**Econ 320 Ch 14 Homework Questions**

__Please, do not use a calculator or any other devices such as cell phones or computers.__

__ __

- If the nominal interest rate in year t is 10%, and the expected inflation rate for year t+1 is 2%, then the real interest rate in year t is approximately ___%.

- 2 B. 3 C. 5 D. 8 E. 12

- With a nominal interest rate of 20%, the present (discounted) value of $600 to be received in one year (that is, 2018) is $ ____.

- 400. B. 500 C. 600 D. 620 E. 720

For questions 3-4, consider the three sequences of incomes below ( P, Q, and R). Each sequence provides a stream of incomes for you, specified below, over the three years.

P Q R

2017 $520 $500 $480

2018 $500 $500 $500

2019 $480 $500 $520

- Assume that the interest rate is 1%. If we rank the three sequences of payments according to their present value of sequence of payments over the three years,

- P > Q > R. B. R > Q > P. C. P > R > Q. D. R > P > Q.

- Assume that the interest rate is 3%. If we rank the three sequences of payments according to their present value of sequence of payments over the three years,

- P > Q > R. B. R > Q > P. C. P > R > Q. D. R > P > Q.

…………………………………………………………………………………………….

- With a nominal interest rate of 3.75%, a deposit of $500 this year will be $___ next year.

- 435 B. 467 C. 487 D. 500 E. 519

- A building generates a rental income of $1M per year, starting from next year, forever. If the interest rate is 10%, the fundamental value of this building is $___M.

- 1 B. 10 C. 50 D. 100

- A building generates a rental income of $1M per year, starting from next year, forever. Assume that the interest rate is 10%. You better purchase the building if the price of the building is $___M.

- 8 B. 12 C. 50 D. 100

- In the short run, the real interest rate and the nominal interest rate tend to move in the same direction, because inflation expectation ___ in the short run.

A.increases. B. decreases C. does not change

- The real interest rate is 5%, and expected inflation is 5%. Assume that you deposit $100 in your savings account today for one year. When you withdraw your money from your savings account next year, the money you withdraw will enable you to buy ____ goods and services next year than the $100 enables you to buy today.

A.more B. fewer C. the same

- You deposit $100 in your savings account today for one year. You will receive more than $100 from your savings account next year as long as

- the nominal interest rate for the savings account is positive.
- the real interest rate for the savings account is positive.
- the expected inflation is positive.
- the real interest rate for the savings account exceeds the nominal rate for the savings account.

- You have to pay a tax of $500 at any time between 1/1/2017 and 4/15/2017. It is your best interest to pay it at ____

- 1/1/2017. B. 4/15/2017. C. any time.

- In the short run, a tax cut causes ______ in the nominal interest rate and ____ in the real interest rate.

- an increase, an increase. B. an increase, a decrease. C. an increase, no change
- a decrease, an increase. E. a decrease, a decrease. F. a decrease, no change

- In the medium run, a tax cut causes ______ in the nominal interest rate and ____ in the real interest rate.

- an increase, an increase. B. an increase, a decrease.
- an increase, no change D. a decrease, an increase.
- a decrease, a decrease. F. a decrease or an increase, a decrease

- Suppose that the Fed cuts money supply. Discuss the effect of this policy on the nominal interest rate, the real interest rate, and output in the short run. In discussing, use an IS-LM graph with correctly labeled curves and axes. If a curve or curves shift in a certain way, explain why the curve or curves shift that way.

- Repeat question 14 in the medium run. Do not use a graph, but use Y = C+I+G in your explanation.

- Explain your answer to question 3. In your explanation, do
__not__calculate or use the present value.

Answer keys

- D 2. B 3. A 4. A 5. E 6. B
- A 8. C. 9. A 10. A 11. B 12. A
- A
- The LM curve shifts up but the IS curve stays the same, increasing both the nominal and real interest rates but decreasing output in the short run. Thus, if we started from the natural (real) interest rate r
_{n}and natural output Y_{n }, the real interest will be higher than the natural rate, but output will be lower than the natural level.

- The real interest rate and output both return to the natural level. The nominal interest will be lower.

- Choose P, and save 20 and enjoy 500 in 2016. The 20 you save in 2016 will be more than 20 in 2018 due to the interest rate, and P is better than Q. By an analogous argument, Q is better than R. Thus, P must be better than Q and R by transitivity.