Unit 7 Assessment Questions

Unit7 Assessment Questions

Q1.What is meant by the demand for money? Which way does the demandcurve for money slope? Why?

Demandfor money is the nominal amount of money demanded divided by theprice level. The demand curve slope downwards due to the followingreasons. Firstly, the demand curve slope due to the real balanceseffects (McEachern,2012).This is the relationship between the price level and the ability ofthe consumers to buy the goods. If the price level decreases andother factors are constant, money become worthy. In this case, thereal value of money goes up. This means that people will afford moregoods and services hence, the quantity demanded increases leading todecrease of the price level. Secondly, the demand curve slopesdownward due to the interest rate effect. Decrease in price levelleads to decrease to interest rate. Whenever interest rate are low,firms and individuals do not need to pay borrow more than they dowhen the rates are high. Therefore, they borrow more to spend toconsumption or investment hence, the quantity demanded increases asthe price level falls.

Q2.Explain how an active policy differs from a passive policy

Thereare significant difference between active policy and passive policy.Active policies are actions defined by government to be done inresponse to economic condition. That is, the procedures that agovernment choose to follow while responding to issue in the economy.Active policy is also known as discretionary policy. Although activepolicies are simple, they are faced by some challenges. For instance,the prejudices and weaknesses of policymakers can translate them toofficial economic policy. On the other hand, the passive policies areconducted according to the present rule. One rule takes into accountmany macroeconomic variables and decides the best action to takedepending with conditions. According to McEachern(2012), passive policies are advantageous because they are short-termdesires of policymakers. The policymakers are always available tocome up with macroeconomic policies and smooth flow of economy.

Q3.How does monetary policy affect aggregate demand in the short run?How does monetary policy affect aggregate demand in the long run?

Monetarypolicy has a significant impact on aggregate demand (AD) in the shortrun. For instance, if the central bank engages in expansionarymonetary policy, there is possibility that it will decrease interestrates. When interest rates are low, consumers start buying items atlow prices. They buy goods such as houses and cars that they commonlybuy using loans. This leads to an increase in aggregate demand. Onthe other hand, this increase in aggregate demand is not sustained inthe long run. McEachern(2012), states that in normal circumstances, people buy more goodswhen interest rates are low. However, this effect does not occurforever. Once they buy houses and cars, they do not continue buyingmore just because the rates are low. Therefore, the monetary policygives the economy a jolt in the short term. Nevertheless, it cannotcreate a situation where aggregate demand will change in the longrun.

Q4.Explain how the short-run Philip Curve, the long-run Philips curve,the short-run aggregate supply curve, the long-run aggregate supplycurve, and the natural rate hypothesis are all related. How do activeand passive views of these concepts differ?

Theshort term Philip curve and short run aggregate supply curve areidentical while the long term Philips curve and long run aggregateare identical. However, although the two set of curves are identical,they are vertical due to the natural rate to unemployment. The shortterm Phillips curve states that the inflation and unemployment ratesare inversely related. That is, when inflation rate is high,unemployment rate is low, and vice versa. Its curve slopes downwardsto the right. On the other hand, the short run aggregate supply curvestates that increase in GDP leads to increase to price level hence,inflation. Similar to short term Philips curve, rise in GDP makesmore people get jobs hence, they produce more goods and services.

Thelong term Philips curve states that there are no connections betweeninflation and unemployment in the long run. There is only single rateof unemployment in the long run that will occur at any inflationrate. The economy can adjust to any price level but willautomatically self-correct itself to achieve full employment. Thisphenomenon is similar to long run aggregate curve. They are bothvertical and price level has no significant impact on economic growth(McEachern,2012).

Inthe natural rate of unemployment, there will be always cases ofunemployment. This is because there are people searching their firstjobs, while others are quitting their current to search for otherbetter jobs. In addition, there are always cases of unemployment dueto globalization, mechanisation, and changing tastes.

Q5.Explain why the Fed can attempt to target either changes in the moneysupply or changes in interest rates, but not both.

TheFed attempts target changes in money supply and interest rateseparately because they can have detrimental effect on inflation.Rapid increase in money supply leads to increase of price inflation.Therefore, the fed attempts to maintain money supply or graduallyincrease it. Similar concept happens with interest rates. Lowinterest rates encourage lending while high interest rate discouragelending.

References

McEachern,W. A. (2012). ECON Macro 3 (3rd ed.). Mason, OH: South-Western.