GENERAL INSTRUCTIONS FOR STUDENTS

MODULE 5: MONETARY POLICY

Fig:1

Question1: The figure1 above shows the demand for money in KSA.                                   (8marks)

a)   If the KSA Central Bank has set the quantity of money so that the equilibrium interest rate is 3 percent, draw the money supply curve in the short-run in the above graph.                   (1mark)

b)   Suppose that KSA Central Bank wants to raise the interest rate by 1 percentage point. By how much must it change the quantity of money?                                                                   (1mark)

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c)   In order to change the quantity of money to raise the interest rate by one percentage point, if the Central Bank uses an open market operation, does it make an open market purchase or an open market sale? Explain your answer.                                                                                 (1mark)

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Fig:2

d)  If the KSA Central Bank has set the quantity of money so that the equilibrium interest rate is 3 percent, draw the supply of money curve in fig2                                                                    (1mark)

e)  Suppose KSA real GDP increases so that the demand for money increases by 100 billion riyals. The KSA Central Bank takes no actions. Show the effects of this event on your figure2. What happens to the interest rate? What happens to the quantity of money in the economy?       (2marks)

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f)   If the Central Bank wants to stop the interest rate from rising, what must it do to the quantity of money? Draw the new money supply curve.                                                                      (1mark)

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g)  In order to change the quantity of money to keep the interest rate constant, suppose the KSA Central Bank uses open market operations. Does it make an open market purchase or an open market sale? Explain your answer.                                                                                      (1mark)

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Question 2:  If the Cental Bank of KSA wants to increase the money supply it decreases interest rates. Which of the following might be a consequence of such a policy?                                        (4marks)

a.    Increases investment                                     (Yes/No)                                                (0.5marks)

b.    Increased costs of production                        (Yes/No)                                                (0.5marks)

c.    Slower growth in potential output                  (Yes/No)                                                (0.5 marks)

d.    Increases inflation                                           (Yes/No)                                               (0.5 marks)

e.    Fall in the  exchange rates                              (Yes/No)                                                (0.5 marks)

f.     Increases Real GDP                                        (Yes/No)                                                (0.5 marks)

g.    Decreases aggregate demand                        (Yes/No)                                                 (0.5 marks)

h.    Increases money demand                                (Yes/No)                                                (0.5 marks)

Question 3: Illustrate the effects of the following on the diagrams below. In each case, show the effect on the rate of interest and national income. Is it the money demand or money supply that will change?Explain with the help of money demand and money supply curves.         (12 marks)

a.    A decline in business confidence:                                                                           (1 mark)

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MD & MS CURVE (2MARKS)

b.    An expansionary fiscal policy:                                                                               (1 mark)

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MD & MS CURVE (2MARKS)

a.    An expansionary monetary policy:                                                                             (1 mark)

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MD & MS CURVE (2MARKS)

b.    A growing belief that asset prices will rise soon.                                       (1 mark)

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MD & MS CURVE (2MARKS)

Question 4:  suppose that central bank increases the money supply by expanding the availability of credit cards so that people need to hold less cash.                                                             (6marks)

a. How does this event affect the demand for money, interest rate and real GD? Draw and explain with the help of money demand and money supply curve.                                                     (1mark)

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MD & MS CURVE (1mark)

b. If the central bank does not take any action, What happens to the price level & Real GDP? Explain with the help of AD and AS curve .                                                                                      (1mark)

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c. If the central bank wants to keep the price level stable, what should it do to the money supply?
(1mark)

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MD & MS CURVE (1mark)

END OF ASSIGNMENT