The Behavior of Interest Rates

5.1 Determinants of Asset Demand

1) Pieces of property that serve as a store of value are called
A) assets.
B) units of account.
C) liabilities.
D) borrowings.

2) Of the four factors that influence asset demand, which factor will cause the
demand for all assets to increase when it increases, everything else held
constant?
A) wealth
B) expected returns
C) risk
D) liquidity

3) If wealth increases, the demand for stocks ________ and that of long -term bonds
________,everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

4) Everything else held constant, a decrease in wealth

A) increases the demand for stocks.
B) increases the demand for bonds.
C) reduces the demand for silver.
D) increases the demand for gold.

5) An increase in an assetʹs expected return relative to that of an alternative

asset, holding everything else constant, ________ the quantity demanded of the
asset.
A) increases
B) decreases
C) has no effect on
D) erases

6) Everything else held constant, if the expected return on ABC stock rises from 5
to 10 percent and the expected return on CBS stock is unchanged, then the
expected return of holding CBS stock ________ relative to ABC stock and the
demand for CBS stock ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls

7) Everything else held constant, if the expected return on U.S. Treasury bonds
falls from 10 to 5 percent and the expected return on GE stock rises from 7 to 8
percent, then the expected return of holding GE stock ________ relative to U.S.
Treasury bonds and the demand for GE stock ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls

8) If housing prices are expected to increase, then, other things equal, the
demand for houses will ________ and that of Treasury bills will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

9) If stock prices are expected to drop dramatically, then, other things equal, the
demand for stocks will ________ and that of Treasury bills will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

10) Everything else held constant, if the expected return on RST stock declines
from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7
percent, then the expected return of holding RST stock ________ relative to XYZ
stock and demand for XYZ stock ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls

11) Everything else held constant, if the expected return on U.S. Treasury bonds
falls from 8 to 7 percent and the expected return on corporate bonds falls from
10 to 8 percent, then the expected return of corporate bonds ________ relative to
U.S. Treasury bonds and the demand for corporate bonds ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls

12) An increase in the expected rate of inflation will ________ the expected return
on bonds relative to the that on ________ assets, everything else held constant.
A) reduce; financial
B) reduce; real
C) raise; financial
D) raise; real

13) If fluctuations in interest rates become smaller, then, other things equal, the
demand for stocks________ and the demand for long-term bonds ________.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

14) If the price of gold becomes less volatile, then, other things equal, the
demand for stocks will ________ and the demand for antiques will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

15) If brokerage commissions on bond sales decrease, then, other things equal,
the demand for bonds will ________ and the demand for real estate will ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

16) If gold becomes acceptable as a medium of exchange, the demand for gold
will ________ and the demand for bonds will ________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; increase
D) increase; decrease

17) The demand for Picasso paintings rises (holding everything else equal) when
A) stocks become easier to sell.
B) people expect a boom in real estate prices.
C) Treasury securities become riskier.
D) people expect gold prices to rise.

18) The demand for silver decreases, other things equal, when
A) the gold market is expected to boom.
B) the market for silver becomes more liquid.
C) wealth grows rapidly.
D) interest rates are expected to rise.

19) You would be less willing to purchase U.S. Treasury bonds, other things
equal, if
A) you inherit $1 million from your Uncle Harry.
B) you expect interest rates to fall.
C) gold becomes more liquid.
D) stock prices are expected to fall.

20) You would be more willing to buy AT&T bonds (holding everything else
constant) if
A) the brokerage commissions on bond sales become cheaper.
B) interest rates are expected to rise.
C) your wealth has decreased.
D) you expect diamonds to appreciate in value.

21) The demand for gold increases, other things equal, when
A) the market for silver becomes more liquid.
B) interest rates are expected to rise.
C) interest rates are expected to fall.
D) real estate prices are expected to increase.

22) Holding everything else constant,

A) if asset Aʹs risk rises relative to that of alternative assets, the demand will
increase for asset A.
B) the more liquid is asset A, relative to alternative assets, the greater will be the
demand for asset A.
C) the lower the expected return to asset A relative to alternative assets, the
greater will be the demand for asset A.
D) if wealth increases, demand for asset A increases and demand for alternative
assets decreases.

23) Holding all other factors constant, the quantity demanded of an asset is
A) positively related to wealth.
B) negatively related to its expected return relative to alternative assets.
C) positively related to the risk of its returns relative to alternative assets.
D) negatively related to its liquidity relative to alternative assets.

24) Everything else held constant, would an increase in volatility of stock prices
have any impact on the demand for rare coins? Why or why not?

5.2 Supply and Demand in the Bond Market

1) In the bond market, the bond demanders are the ________ and the bond
suppliers are the ________.
A) lenders; borrowers
B) lenders; advancers
C) borrowers; lenders
D) borrowers; advancers

2) The demand curve for bonds has the usual downward slope, indicating that at
________ prices of the bond, everything else equal, the ________ is higher.
A) higher; demand
B) higher; quantity demanded
C) lower; demand
D) lower; quantity demanded

3) The supply curve for bonds has the usual upward slope, indicating that as the
price ________, ceteris paribus, the ________ increases.
A) falls; supply
B) falls; quantity supplied
C) rises; supply
D) rises; quantity supplied
4) In the bond market, the market equilibrium shows the market-clearing ________
and market-clearing ________.
A) price; deposit
B) interest rate; deposit
C) price; interest rate
D) interest rate; premium

5) When the price of a bond is above the equilibrium price, there is an excess
________ bonds and price will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise

6) When the price of a bond is ________ the equilibrium price, there is an excess
demand for bonds and price will ________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise

7) When the interest rate on a bond is above the equilibrium interest rate, in the
bond market there is excess ________ and the interest rate will ________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise

8) When the interest rate on a bond is ________ the equilibrium interest rate, in the
bond market there is excess ________ and the interest rate will ________.
A) above; demand; rise
B) above; demand; fall
C) below; supply; fall
D) above; supply; rise

9) A situation in which the quantity of bonds supplied exceeds the quantity of

bonds demanded is called a condition of excess supply; because people want to
sell ________ bonds than others want to buy, the price of bonds will ________.
A) fewer; fall
B) fewer; rise
C) more; fall
D) more; rise

10) If the price of bonds is set ________ the equilibrium price, the quantity of bonds
demanded exceeds the quantity of bonds supplied, a condition called excess
________.
A) above; demand
B) above; supply
C) below; demand
D) below; supply

5.3 Changes in Equilibrium Interest Rates

1) A movement along the bond demand or supply curve occurs when ________
changes.
A) bond price
B) income
C) wealth
D) expected return

2) When the price of a bond decreases, all else equal, the bond demand curve
________.
A) shifts right
B) shifts left
C) does not shift
D) inverts

3) During business cycle expansions when income and wealth are rising, the
demand for bonds ________ and the demand curve shifts to the ________, everything
else held constant.
A) falls; right
B) falls; left
C) rises; right
D) rises; left

4) Everything else held constant, when households save less, wealth and the
demand for bonds ________ and the bond demand curve shifts ________.
A) increase; right
B) increase; left
C) decrease; right
D) decrease; left

5) Everything else held constant, if interest rates are expected to fall in the
future, the demand for long-term bonds today ________ and the demand curve
shifts to the ________.
A) rises; right
B) rises; left
C) falls; right
D) falls; left

6) Holding the expected return on bonds constant, an increase in the expected

return on common stocks would ________ the demand for bonds, shifting the
demand curve to the ________.
A) decrease; left
B) decrease; right
C) increase; left
D) increase; right
7) Everything else held constant, an increase in expected inflation, lowers the
expected return on________ compared to ________ assets.
A) bonds; financial
B) bonds; real
C) physical; financial
D) physical; real

8) Everything else held constant, an increase in the riskiness of bonds relative to

alternative assets causes the demand for bonds to ________ and the demand curve
to shift to the ________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left

9) Everything else held constant, when stock prices become less volatile, the
demand curve for bonds shifts to the ________ and the interest rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises

10) Everything else held constant, when stock prices become ________ volatile, the
demand curve for bonds shifts to the ________ and the interest rate ________.
A) more; right; rises
B) more; right; falls
C) less; left; falls
D) less; left; does not change

11) Everything else held constant, an increase in the liquidity of bonds results in
a ________ in demand for bonds and the demand curve shifts to the ________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left

12) Everything else held constant, when bonds become less widely traded, and
as a consequence the market becomes less liquid, the demand curve for bonds
shifts to the ________ and the interest rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises

13) The reduction of brokerage commissions for trading common stocks that
occurred in 1975 caused the demand for bonds to ________ and the demand curve
to shift to the ________.
A) fall; right
B) fall, left
C) rise; right
D) rise; left

14) Factors that decrease the demand for bonds include

A) an increase in the volatility of stock prices.
B) a decrease in the expected returns on stocks.
C) a decrease in the inflation rate.
D) a decrease in the riskiness of stocks.

15) During a recession, the supply of bonds ________ and the supply curve shifts to
the ________, everything else held constant.
A) increases; left
B) increases; right
C) decreases; left
D) decreases; right

16) In a business cycle expansion, the ________ of bonds increases and the ________
curve shifts to the ________ as business investments are expected to be more
profitable.
A) supply; supply; right
B) supply; supply; left
C) demand; demand; right
D) demand; demand; left

17) When the expected inflation rate increases, the real cost of borrowing ________
and bond supply ________, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

18) An increase in the expected inflation rate causes the supply of bonds to
________ and the supply curve to shift to the ________, everything else held constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

19) Higher government deficits ________ the supply of bonds and shift the supply
curve to the ________, everything else held constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

20) Factors that can cause the supply curve for bonds to shift to the right include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) a decrease in government deficits.
D) a business cycle recession.

21) When the inflation rate is expected to increase, the ________ for bonds falls,
while the ________ curve shifts to the right, everything else held constant.
A) demand; demand
B) demand; supply
C) supply; demand
D) supply; supply

22) When the expected inflation rate increases, the demand for bonds ________,
the supply of bonds ________, and the interest rate ________, everything else held
constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises

23) Everything else held constant, when the inflation rate is expected to rise,
interest rates will ________; this result has been termed the ________.
A) fall; Keynes effect
B) fall; Fisher effect
C) rise; Keynes effect
D) rise; Fisher effect

24) The economist Irving Fisher, after whom the Fisher effect is named,
explained why interest rates________ as the expected rate of inflation ________,
everything else held constant.
A) rise; increases
B) rise; stabilizes
C) fall; stabilizes
D) fall; increases

25) Everything else held constant, during a business cycle expansion, the supply
of bonds shifts to the ________ as businesses perceive more profitable investment
opportunities, while the demand for bonds shifts to the ________ as a result of the
increase in wealth generated by the economic expansion.
A) right; left
B) right; right
C) left; left
D) left; right

26) When the economy slips into a recession, normally the demand for bonds
________, the supply of bonds ________, and the interest rate ________, everything else
held constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
27) When an economy grows out of a recession, normally the demand for bonds
________ and the supply of bonds ________, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

28) Deflation causes the demand for bonds to ________, the supply of bonds to
________, and bond prices to ________, everything else held constant.
A) increase; increase; increase
B) increase; decrease; increase
C) decrease; increase; increase
D) decrease; decrease; increase

29) In the 1990s Japan had the lowest interest rates in the world due to a
combination of
A) inflation and recession.
B) deflation and expansion.
C) inflation and expansion.
D) deflation and recession.

30) When the interest rate changes,

A) the demand curve for bonds shifts to the right.
B) the demand curve for bonds shifts to the left.
C) the supply curve for bonds shifts to the right.
D) it is because either the demand or the supply curve has shifted.

31) The interest rate falls when either the demand for bonds ________ or the
supply of bonds ________.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

32) When the government has a surplus, as occurred in the late 1990s, the
________ curve of bonds shifts to the ________, everything else held constant.
A) supply; right
B) supply; left
C) demand; right
D) demand; left

33) A decrease in the brokerage commissions in the housing market from 6% to

5% of the sales price will shift the ________ curve for bonds to the ________,
everything else held constant.
A) demand; right
B) demand; left
C) supply; right
D) supply; left
34) When rare coin prices become volatile, the ________ curve for bonds shifts to
the ________, everything else held constant.
A) demand; right
B) demand; left
C) supply; right
D) supply; left

35) If people expect real estate prices to increase significantly, the ________ curve
for bonds will shift to the ________, everything else held constant.
A) demand; right
B) demand; left
C) supply; left
D) supply; right

36) Everything else held constant, when prices in the art market become more
uncertain,
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the demand curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate falls.

37) Everything else held constant, when real estate prices are expected to
decrease
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the demand curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate falls.

38) Everything else held constant, when the government has higher budget
deficits
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the supply curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate rises.

39) If stock prices are expected to climb next year, everything else held constant,
the ________ curve for bonds shifts ________ and the interest rate ________.
A) demand; left; rises
B) demand; right; rises
C) demand; left; falls
D) supply; left; rises

40) If prices in the bond market become more volatile, everything else held
constant, the demand curve for bonds shifts ________ and interest rates ________.
A) left; rise
B) left; fall
C) right; rise
D) right; fall
41) If brokerage commissions on stocks fall, everything else held constant, the
demand for bonds ________, the price of bonds ________, and the interest rate________.
A) decreases; decreases; increases
B) decreases; decreases; decreases
C) increases; decreases; increases
D) increases; increases; increases

42) If the expected return on bonds increases, all else equal, the demand for
bonds increases, the price of bonds ________, and the interest rate ________.
A) increases; decreases
B) increases; increases
C) decreases; decreases
D) decreases; increases

43) In the figure above, a factor that could cause the supply of bonds to shift to
the right is:
A) a decrease in government budget deficits.
B) a decrease in expected inflation.
C) a recession.
D) a business cycle expansion.

44) In the figure above, a factor that could cause the demand for bonds to
decrease (shift to the left) is:
A) an increase in the expected return on bonds relative to other assets.
B) a decrease in the expected return on bonds relative to other assets.
C) an increase in wealth.
D) a reduction in the riskiness of bonds relative to other assets.

45) In the figure above, the price of bonds would fall from P1 to P2
A) inflation is expected to increase in the future.
B) interest rates are expected to fall in the future.
C) the expected return on bonds relative to other assets is expected to increase
in the future.
D) the riskiness of bonds falls relative to other assets.

5.4 Supply and Demand in the Market for Money: The Liquidity Preference
Framework
1) In Keynesʹs liquidity preference framework, individuals are assumed to hold
their wealth in two forms:
A) real assets and financial assets.
B) stocks and bonds.
C) money and bonds.
D) money and gold.

2) In Keynesʹs liquidity preference framework,

A) the demand for bonds must equal the supply of money.
B) the demand for money must equal the supply of bonds.
C) an excess demand of bonds implies an excess demand for money.
D) an excess supply of bonds implies an excess demand for money.

3) In Keynesʹs liquidity preference framework, if there is excess demand for

money, there is
A) excess demand for bonds.
B) equilibrium in the bond market.
C) excess supply of bonds.
D) too much money.

4) The bond supply and demand framework is easier to use when analyzing the
effects of changes in ________, while the liquidity preference framework provides a
simpler analysis of the effects from changes in income, the price level, and the
supply of ________.
A) expected inflation; bonds
B) expected inflation; money
C) government budget deficits; bonds
D) government budget deficits; money

5) Keynes assumed that money has ________ rate of return.

A) a positive
B) a negative
C) a zero
D) an increasing

6) In his Liquidity Preference Framework, Keynes assumed that money has a

zero rate of return; thus,
A) when interest rates rise, the expected return on money falls relative to the
expected return on bonds, causing the demand for money to fall.
B) when interest rates rise, the expected return on money falls relative to the
expected return on bonds, causing the demand for money to rise.
C) when interest rates fall, the expected return on money falls relative to the
expected return on bonds, causing the demand for money to fall.
D) when interest rates fall, the expected return on money falls relative to the
expected return on bonds, causing the demand for money to rise.

7) In Keynesʹs liquidity preference framework, as the expected return on bonds

increases (holding everything else unchanged), the expected return on money
________, causing the demand for ________ to fall.
A) falls; bonds
B) falls; money
C) rises; bonds
D) rises; money

8) The opportunity cost of holding money is

A) the level of income.
B) the price level.
C) the interest rate.
D) the discount rate.

9) An increase in the interest rate

A) increases the demand for money.
B) increases the quantity of money demanded.
C) decreases the demand for money.
D) decreases the quantity of money demanded.

10) If there is an excess supply of money

A) individuals sell bonds, causing the interest rate to rise.
B) individuals sell bonds, causing the interest rate to fall.
C) individuals buy bonds, causing interest rates to fall.
D) individuals buy bonds, causing interest rates to rise.

11) When the interest rate is above the equilibrium interest rate, there is an
excess ________ money and the interest rate will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise

12) In the market for money, an interest rate below equilibrium results in an
excess ________ money and the interest rate will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise

5.5 Changes in Equilibrium Interest Rates in the Liquidity Preference Framework

1) In the Keynesian liquidity preference framework, an increase in the interest
rate causes the demand curve for money to ________, everything else held
constant.
A) shift right
B) shift left
C) stay where it is
D) invert

2) A lower level of income causes the demand for money to ________ and the
interest rate to ________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase

3) When real income ________, the demand curve for money shifts to the ________
and the interest rate ________, everything else held constant.
A) falls; right; rises
B) rises; right; rises
C) falls; left; rises
D) rises; left; rises

4) A business cycle expansion increases income, causing money demand to

________ and interest rates to ________, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

5) In the Keynesian liquidity preference framework, a rise in the price level

causes the demand for money to ________ and the demand curve to shift to the
________, everything else held constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

6) When the price level ________, the demand curve for money shifts to the ________
and the interest rate ________, everything else held constant.
A) falls; left; falls
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises

7) A rise in the price level causes the demand for money to ________ and the
interest rate to________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase

21) In the liquidity preference framework, a one-time increase in the money

supply results in a price level effect. The maximum impact of the price level effect
on interest rates occurs
A) at the moment the price level hits its peak (stops rising) because both the
price level and expected inflation effects are at work.
B) immediately after the price level begins to rise, because both the price level
and expected inflation effects are at work.
C) at the moment the expected inflation rate hits its peak.
D) at the moment the inflation rate hits it peak.

22) Of the four effects on interest rates from an increase in the money supply, the
one that works in the opposite direction of the other three is the
A) liquidity effect.
B) income effect.
C) price level effect.
D) expected inflation effect.

23) It is possible that when the money supply rises, interest rates may ________ if
the ________effect is more than offset by changes in income, the price level, and
expected inflation.
A) fall; liquidity
B) fall; risk
C) rise; liquidity
D) rise; risk

24) When the growth rate of the money supply increases, interest rates end up
being permanently lower if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.

25) When the growth rate of the money supply is increased, interest rates will
fall immediately if the liquidity effect is ________ than the other money supply
effects and there is ________adjustment of expected inflation.
A) larger; fast
B) larger; slow
C) smaller; slow
D) smaller; fast