Tackle the Test: Free-Response Questions
Question
Draw three correctly labeled graphs of the money market. Show the effect of each of the following three changes on a separate graph.
The aggregate price level increases.
Real GDP falls.
There is a dramatic increase in online banking.
Rubric for FRQ 1 (6 points)
1 point: The vertical axis is labeled “Interest rate” or “r” and the horizontal axis is labeled “Quantity of money.”
1 point: The money supply curve is vertical and labeled.
1 point: The money demand curve is negatively sloped and labeled.
1 point: The money demand curve shifts right.
1 point: The money demand curve shifts left.
1 point: The money demand curve shifts left.
Question
Draw a correctly labeled graph showing equilibrium in the money market. Label the equilibrium interest rate rE and label an interest rate below the equilibrium interest rate rL. Explain what occurs in the market when the interest rate is rL and how the market will eventually return to equilibrium. (7 points)
Rubric for FRQ 2 (7 points)
1 point: The vertical axis is labeled “Interest rate” or “r ” and the horizontal axis is labeled “Quantity of money.”
1 point: Money supply curve is vertical and labeled.
1 point: Money demand curve is negatively sloped and labeled.
1 point: The equilibrium interest rate is labeled on the vertical axis and a rate below the equilibrium rate is also labeled.
1 point: At an interest rate below equilibrium, the quantity of money demanded exceeds the quantity of money supplied.
1 point: People want to shift more of their wealth out of interest-bearing assets such as CDs and hold it as money instead. Because the quantity of interest-bearing nonmoney assets demanded is less than the quantity supplied, those trying to sell such assets will have to offer a higher interest rate to attract buyers.
1 point: As the interest rate rises, the quantity of money demanded decreases. This process continues until the market returns to equilibrium.