Question

1. The interest rate on Treasury bills (with short maturities) can be thought of as the opportunity cost of holding (non-interest bearing) money. We think of the money stock as being determined by the Federal Reserve. In the liquidity preference graph, we put the interest rate on the vertical axis and the amount of money supplied and demanded on the horizontal axis. An increase in the money supply a. shifts the demand for money curve to the left, which causes the interest rate to fall b. shifts the vertical money supply line to the right, which causes the interest rate to fall 2. An increase in income a. shifts the demand for money curve to the right, which causes the interest rate to rise b. shifts the vertical money supply line to the left, which causes the interest rate to rise 3. Why does an increase in the money supply cause the interest rate to fall? a. when the money supply increases, people find that they are holding more money in their accounts than they need, and to reduce their holdings of money, they sell some of the Treasury bills, which causes the interest rate to fall b. when the money supply increases, people find that they are holding more money in their accounts than they need, and to reduce their holdings of money, they buy Treasury bills, which causes the interest rate to fall 4. In the market for Treasury bonds (with long maturities) some of these bonds are held by foreign investors. Suppose some of these investors decide to sell their bonds. This causes the interest rate on Treasury bonds to a. rise b. fall 5. When the Federal Reserve buys Treasury bills in the open market, this causes the interest rate on these bills to a. rise b. fall 6. You are planning to buy a Treasury bill that will mature in three months at a value of $100. The market price of the bill is $97. You wait for a couple of days and find that now you would have to pay $98 for the bill. Has the interest rate gone up or down? a. up b. down

Answer 1

Question 1

In the Liquidity preference theory, money supply is taken as fixed and is independent of the interest rate.

It is determined by the central bank.

So,

An increase in money supply shifts the vertically straight money supply curve to the right.

Given the money demand curve, the rightward shift of the money supply curve results in a decrease in the interest rate.

Thus,

The correct answer is the option (b) [Shifts the vertical money supply line to the right, which causes the interest rate to fall].