Answer the questions below.

Consider an economy where the demand for real money balances and the demand for investment

are both highly interest-elastic. A change in the money supply will give:

A a relatively small change in the rate of interest and the level of investment.

B a relatively large change in the rate of interest and the level of investment.

C a relatively large change in the rate of interest and a relatively small change in the level of

investment.

D a relatively small change in the rate of interest and a relatively large change in the level of

investment.

An increase in government expenditure financed by government borrowing from the non-bank

private sector is most likely to:

A increase the supply of money, reduce interest rates and increase national income.

B increase the demand for money, reduce interest rates and cause private sector

investment to rise.

C increase the demand for money, increase interest rates and cause private sector

investment to fall.

D increase the demand for and the supply of money, leave interest rates unchanged and

increase national income.

18.3 Points on the IS curve show combinations of real Gross Domestic Product (GDP) and the rate of

interest where:

A the economy is at full employment.

B the money market is in equilibrium.

C aggregate demand equals aggregate supply so that the product market is in equilibrium.

D both the product and money markets are in equilibrium.

Explain the theory behind how monetary policy can be used to control inflation and discuss some

of the practical problems associated with using monetary policy to control inflation.

(i) Using a single diagram plot an IS curve and an LM curve. Explain what these curves and

their point of intersection denote. [5]

(ii) Use the IS-LM model to explain and illustrate crowding out resulting from an increase in

government spending.

Using a diagram of the IS-MP model, explain the effects on real interest rates and real national

income of an increase in investment in new technology that increases potential national income.

Consider the life insurance policy described in Example 8.2.1. Display, fo 0 [Px - Uqxth(1 - #+1 V )](1 + i )*-h. 1= 0 Give an interpretation of the formulas in words. If bu+1 = h+IV, oV = 0, and Th = T, for h = 0, 1, . .., k - 1, prove that , V = TSK . [Hint: Use (8.3.14).] Show that if i is the level annual benefit premium for an n-year term insur ance with b, = and , h = 1, 2, . . . . n, OV = ,V = 0, then a. T = an - axin axn b. V = am x - axtkn k - Taxthin-Al. [Hint: This can be shown directly or by use of (8.3.10).] on 8.4 Starting with (8.4.3), establish the equation sPxth ntsV + Ul- $9xth bn+1 = (1 + i)(V+ mn) 0