ASSIGNMENT 6

BEEB 2023 MACROECONOMICS

SEMESTER II 2016/2017 SESSION (A162)

Instruction: Answer all the questions. Your answers must be typed. You are required to
submit your assignment before or on 13 April 2017 (Thursday).

1. How the rate of interest is determined according to classical theory?

(5 markah/marks)

2. With the aid of an appropriate diagram, explain and demonstrate the effect of the following
events on the equilibrium level of quantity of money and interest rate:

(a) The central bank sells securities to the public. (4 markah/marks)

(b) An increase in income level. (4 markah/marks)

(c) A decline in bank rate. (4 markah/marks)

3. What is the difference between the liquidity and liquidity trap? (5 markah/marks)
Liquidity is an asset of being easily converted into cash quickly and at little cost and
without any price discount. The more quickly an asset is converted into money the more
liquid it is said to be. According to Keynes, demand for liquidity is determined by three
motives: transaction motive, precaution motive and speculative motive. Liquidity trap is a
situation in a severe recession in which the central banks injection of additional reserves
into banking system has little or no additional positive impact on lending, borrowing,
investment, or aggregate demand. It unable to stimulate an economy, either through
lowering interest rates or increasing the money supply.

4. Given:
Money supply function: MS = 400
Money demand function: MD = 200 + 0.5Y 300r
If the income level, Y is 450,

(a) i. derive the money demand function in the form of MD = f(r). (3 markah/marks)

ii. find equilibrium quantity of money and interest rate levels. (5 markah/marks)

iii. show your answer in (ii) using an appropriate diagram. (5 markah/marks)

(b) Suppose that MS decrease to 375, repeat questions (a) ii & iii. (5 markah/marks)

(c) Suppose that MS and Y are remain constant but the autonomous MD increase to 300,
repeat questions (a) ii & iii. (5 markah/marks)
5. With the aid of appropriate diagrams, explain and demonstrate the effect of a reduction in
money supply on the equilibrium level of income. (5 markah/marks)

SOALAN TAMAT
END OF QUESTIONS