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Monetary Policy and Growth
Directions: Answer the following questions completely. Be sure to use graphs when asked or
to explain your work and to explain completely any situation that asks for a reason. 1. Interest rates in the country of Martinville are important to explaining economic
activity and changes in the economy.
A) Using a correctly labeled graph of the money market, show how a decrease in
nominal GDP will affect the interest rate in Martinville. Is this interest rate
nominal or real?
B) Using a correctly labeled graph of the loanable funds market, show how a major
spending spree by those who were saving for the future will affect the interest
rate. Is this interest rate nominal or real?
C) Suppose the nominal interest rate has been 8 percent.
a. If inflation is expected to be 5 percent what is the real interest rate?
b. If deflation is expected to be 3 percent what is the real interest rate?
D) The Central Bank of Martinville, known as The APEX buys bonds in the open
a) What is the effect this will have on the ability of banks to make loans in
Martinville? Why might The APEX do this?
b) Show the effect of this action on the Money market, Investment Demand,
Aggregate Expenditures and Aggregate Supply and Aggregate Demand.
c) What will be the effect of this action on?
i) the price level
ii) the real rate of interest
iii) Output and employment