Money, Banking, and Monetary Policy Review Questions Review for AP Economics

The study guides for these review questions can be found at:

• Money and Financial Assets Review for AP Economics
• Fractional Reserve Banking and Money Creation Review for AP Economics
• Monetary Policy Review for AP Economics

Questions

1. Which function of money best defines $1.25 as the price of a 20 oz. bottle of pop?
   1. Medium of exchange.
   2. Unit of account.
   3. Store of value.
   4. Transfer of ownership.
   5. Fiat money.
2. If a bank has $500 in checking deposits and the bank is required to reserve $50, what is the reserve ratio? How much does the bank have in excess reserves?
   1. 10 percent, $450 in excess reserves.
   2. 90 percent, $50 in excess reserves.
   3. 90 percent, $450 in excess reserves.
   4. 10 percent, $50 in excess reserves.
   5. 10 percent, $500 in excess reserves.
3. Which is NOT a way that the Fed can affect the money supply?
   1. A change in discount rate.
   2. An open market operation.
   3. A change in reserve ratio.
   4. A change in tax rates.
   5. Buying Treasury securities from commercial banks.
4. If the money supply increases, what happens in the money market? (Assuming money demand is downward sloping)
   1. The nominal interest rates rises.
   2. The nominal interest rates falls.
   3. The nominal interest rate does not change.
   4. Transaction demand for money falls.
   5. Transaction demand for money rises.
5. To move the economy closer to full employment, the central bank decides that the federal funds rate must be increased. The appropriate open market operation is to ______, which ______ the money supply, ______ aggregate demand, and fight ______.



6. Which of the following is a predictable advantage of expansionary monetary policy in a recession?
   1. Decreases aggregate demand so that the price level falls.
   2. Increases aggregate demand, which increases real GDP and increases employment.
   3. Increases unemployment, but low prices negate this effect.
   4. It keeps interest rates high, which attracts foreign investment.
   5. It boosts the value of the dollar in foreign currency markets.

Answers and Explanations

1. B—The price in this case measures the relative price (value) of the pop.
2. A—The reserve ratio = Required reserves/checking deposits = .1 = 10%. Excess reserves = (checking deposits – required reserves) = ($500 – $50) = $450.
3. D—The Fed has no control of tax rates, which are an example of fiscal policy. All of the other choices are tools of monetary policy.
4. B—If the demand for money is downward sloping, the nominal interest rate falls because the money supply curve has shifted rightward.
5. E—If the central bank has decided that moving to full employment requires an increase in the federal funds rate, it must sell bonds to decrease the money supply. The resulting increase in interest rates decreases AD and puts downward pressure on the price level.
6. B—Expansionary monetary policies decrease the interest rate causing AD to increase, which increases GDP at equilibrium and increases employment.