MGT411 Midterm Subjective

MGT411 Subjective Material

Q49. What is the effect of an increase in potential output on inflation and output? Solution:- (3 marks)

The Effects of an increase in potential Output on Inflation and Output An increase in potential output shifts the LRAS curve to the right. In the short run, current output remains unchanged. But since current output is now below potential output, the resulting recessionary gap places downward pressure on inflation and output eventually begin to rise.

Q50. Give an account of different components of aggregate demand? Solution:- (3 marks)

Aggregate demand is divided into four components:

1. Consumption,
2. Investment,
3. Government purchases,
4. Net exports

Investment is the most important of the components of aggregate demand that are sensitive to changes in the real interest rate. Consumption and net exports also respond to the real interest rate; Aggregate Govt.’s Net Demand = Consumption + Investment + Purchases + Exports

Q51. Give brief explanation of the following. (5 marks)

a)What is Target funds rate?

Solution:- The target federal funds rate is the central bank’s primary policy instrument. It is Interest rate charged on overnight loans between banks

b) How it is controlled?

Solution:- The central bank chooses to control the federal funds rate by manipulating the quantity of reserves through open market operations: the central bank buys or sells securities to add or drain reserves as required.

c)What will be the impact of target federal rate on economy?

Solution:- Changes interest rates throughout the economy When central bank targets the quantity of reserves, a shift in reserve demand causes the market federal funds rate to move. An increase in reserve demand forces the interest rate up, while a fall in reserve demand forces the interest rate down.

Q52. Solution:- (5 marks)

A well-designed policy framework also helps policymakers establish credibility. The Principles of Central Bank Design
Independence: To keep inflation low, monetary decisions must be made free of political influence
Decision making by committee: Pooling the knowledge of a number of people yields better decisions than decision making by an individual
Accountability and transparency: Policy makers must be held accountable to the public they serve and clearly communicate their objectives, decisions and methods
Policy framework: Politicians must clearly state their policy goals and the tradeoffs among them

Q53. “Monetary policy makers react to changes in current inflation by changing the real interest rate”. Discuss. (5 marks)

Solution:- Monetary policy makers react to changes in current inflation by changing the real interest rate. Increases in current inflation lead them to raise the real interest rate, while decreases lead them to lower it. The monetary policy reaction curve is located so that the central bank’s target inflation is consistent with the long-run real interest rate, which equates aggregate demand with potential output. When policymakers adjust the real interest rate they are either moving along a fixed monetary policy reaction curve or shifting the curve. A movement along the curve is a reaction to a change in current inflation; a shift in the curve represents a change in the level of the real interest rate at every level of inflation.

Q49. What are the factors that affect the quantity of money? (3 marks)

Q50. Question No: 51 ( Marks: 5 ) (3 marks)

Q52. Question No: 53 ( Marks: 5 ) (5 marks)

Which relationship is shown by the monetary policy reaction curve?

factors change?

1. An increase in the Central Bank’s Inflation Target