1. Describe the functions of money. 2. What is fiat money? What is commodity money? 3. What are the various ways,in which the Federal Reserve can influence' the money supply? 4. Write the quantity equation and explain it. 5. What does the assumption of constant velocity imply? 6. If inflation rises from 6 percent to 8 percent, what happens to real and nominal interest rates, according to the Fisher effect? 7. Define net capital outflow and trade balance Explain how they are related. 8. Define nominal exchange rate and real exchange rate. 9. If a small open economy cuts defense spending, what happens to saving.investment, the trade balance, the interest rate, and the exchange rate? Explain using the graph.

Question

1. Describe the functions of money. 2. What is fiat money? What is commodity money? 3. What are the various ways,in which the Federal Reserve can influence' the money supply? 4. Write the quantity equation and explain it. 5. What does the assumption of constant velocity imply? 6. If inflation rises from 6 percent to 8 percent, what happens to real and nominal interest rates, according to the Fisher effect? 7. Define net capital outflow and trade balance Explain how they are related. 8. Define nominal exchange rate and real exchange rate. 9. If a small open economy cuts defense spending, what happens to saving.investment, the trade balance, the interest rate, and the exchange rate? Explain using the graph.

Answer 1

1. The functions of money are: - Medium of exchange: Money is used as an intermediary in trade to avoid the complications of a barter system. - Store of value: Money can be saved and retrieved in the future, maintaining its value over time. - Unit of account: Money provides a common measure for valuing goods and services, allowing for easy comparison and pricing.2. Fiat money is currency that is not backed by a physical commodity but rather by the government that issued it. Commodity money, on the other hand, is currency that is backed by a physical good, such as gold or silver.3. The Federal Reserve can influence the money supply through: - Open market operations: Buying and selling government securities to increase or decrease the money supply. - Discount rate: Changing the interest rate at which banks can borrow from the Fed, affecting the money supply. - Reserve requirements: Adjusting the amount of funds that banks must hold in reserve, impacting their ability to lend the money supply.4. The quantity equation is: MV = PY. It states that the money supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by the real output (Y). This equation shows the relationship between the money supply and the overall level of economic activity.5. The assumption of constant velocity implies that the speed at which money changes hands in the economy remains constant over time. This means that the velocity of money does not change, and any changes in the money supply will directly affect the price level.6. According to the Fisher effect, if inflation rises from 6 percent to 8 percent, the nominal interest rate will increase by the same amount (2 percentage points), while the real interest rate remains unchanged.7. Net capital outflow refers to the difference between a country's capital outflows (investments made abroad) and its capital inflows (foreign investments made domestically). The trade balance is the difference between a country's exports and imports. They are related in that a country with a surplus in its trade balance will typically have a net capital outflow, while a country with a deficit in its trade balance will typically have a net capital inflow.8. The nominal exchange rate is the rate at which one currency can be exchanged for another currency. The real exchange rate, on the other hand, takes into account the relative prices of goods and services between two countries, adjusting for differences in price levels.9. If a small open economy cuts defense spending, it will lead to an increase in saving and investment, as resources are redirected towards productive activities. This can improve the trade balance, as the economy becomes more competitive internationally. The interest rate may decrease due to increased saving, and the exchange rate may appreciate as the economy becomes more attractive to foreign investors.

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