Questions and Answers

1. What was the primary means of exchange before money was invented?

A) Credit
B) Barter
C) Gift economy
D) Trade agreements

Answer: B) Barter
Explanation: Barter was the method used for exchanging goods and services directly without a medium
of exchange.

2. Why was the barter system considered inefficient?

A) It required formal contracts.

B) It required double coincidence of wants.
C) It was too fast-paced.
D) It limited trades to local markets.

Answer: B) It required double coincidence of wants.

Explanation: In barter, both parties must want what the other has, making transactions difficult.

3. Which of the following served as money in pre-Revolutionary America?

A) Gold coins
B) Spanish doubloons
C) Paper notes
D) Barter goods

Answer: B) Spanish doubloons

Explanation: Before the Revolutionary War, Spanish doubloons were commonly used as money in
America.

4. What type of money was used in Ethiopia historically?

A) Gold coins
B) Salt
C) Paper notes
D) Digital currency

Answer: B) Salt
Explanation: Salt (referred to as Amole) served as a form of money in Ethiopia for many years.
5. What is the modern form of money issued by governments called?

A) Commodity money
B) Fiat money
C) Credit money
D) Electronic money

Answer: B) Fiat money

Explanation: Fiat money is government-issued currency that is not backed by a physical commodity but
is accepted as a medium of exchange.

6. Which of the following is NOT a function of money?

A) Medium of exchange
B) Store of value
C) Measure of inflation
D) Unit of account

Answer: C) Measure of inflation

Explanation: Money functions as a medium of exchange, store of value, and unit of account, but it does
not measure inflation.

7. What is the primary function of money as a medium of exchange?

A) To store value
B) To facilitate transactions
C) To measure economic performance
D) To serve as a standard of deferred payments

Answer: B) To facilitate transactions

Explanation: As a medium of exchange, money allows for easier transactions compared to bartering.

8. Money must meet certain criteria to function effectively. Which of the following is NOT one of
those criteria?

A) Standardization
B) Portability
C) Scarcity
D) Durability

Answer: C) Scarcity
Explanation: While money needs to be standardized, portable, and durable, scarcity is not a functional
requirement.
9. What does it mean for money to serve as a "measure of value"?

A) It quantifies the amount of cash one has.

B) It provides a way to compare the value of different goods and services.
C) It indicates how much money is in circulation.
D) It is used to measure inflation rates.

Answer: B) It provides a way to compare the value of different goods and services.
Explanation: Money allows for the expression of the value of all goods and services, facilitating
economic calculations.

10. What is the standard of deferred payments function of money?

A) Money can be used to store wealth.

B) Money acts as a benchmark for future payments.
C) Money is used to pay for immediate transactions.
D) Money represents ownership of goods.

Answer: B) Money acts as a benchmark for future payments.

Explanation: This function makes it easier to calculate and make payments owed in the future.

11. Which of the following is an example of credit money?

A) Gold coins
B) Paper currency
C) Checks
D) Silver bullion

Answer: C) Checks
Explanation: Credit money includes negotiable instruments like checks, which facilitate transactions
without cash.

12. How does money function as a "store of value"?

A) It appreciates over time.

B) It retains purchasing power for future use.
C) It generates interest automatically.
D) It cannot be converted back to goods.

Answer: B) It retains purchasing power for future use.

Explanation: Money allows individuals to save their purchasing power for future transactions.

13. What is one of the main problems associated with barter systems?
A) High transaction costs
B) Excessive currency
C) Lack of goods
D) Uniform pricing

Answer: A) High transaction costs

Explanation: Barter requires finding mutually acceptable goods, leading to high transaction costs.

14. What does commodity money refer to?

A) Currency issued by central banks

B) Money made from precious metals
C) Any valuable item used as money
D) Digital currencies

Answer: C) Any valuable item used as money

Explanation: Commodity money consists of items that have intrinsic value and can be used as a medium
of exchange.

15. What is metallic money primarily made of?

A) Paper
B) Precious metals
C) Plastic
D) Digital formats

Answer: B) Precious metals

Explanation: Metallic money refers to coins made from metals, often gold or silver.

16. Why was the introduction of coinage significant?

A) It eliminated the need for all forms of money.

B) It standardized the form and value of money.
C) It made barter more efficient.
D) It replaced paper money entirely.

Answer: B) It standardized the form and value of money.

Explanation: Coinage allowed for a consistent medium of exchange, making transactions easier.

17. What is the primary disadvantage of paper money?

A) It is easily stolen.
B) It is too heavy to carry.
C) It cannot be used for large transactions.
D) It has no intrinsic value.

Answer: A) It is easily stolen.

Explanation: Paper money can be physically taken and is not as secure as other forms of money.

18. What does the term "electronic means of payment" refer to?

A) Cash transactions
B) Digital transactions using technology
C) Bartering
D) Paper checks

Answer: B) Digital transactions using technology

Explanation: Electronic means of payment include digital transactions made through devices and online
platforms.

19. Which of the following is NOT considered a function of money?

A) Store of value
B) Medium of exchange
C) Measure of credit risk
D) Unit of account

Answer: C) Measure of credit risk

Explanation: Money does not measure credit risk; it functions primarily as a medium of exchange, store
of value, and unit of account.

20. What is one advantage of credit money?

A) It requires carrying cash.

B) It simplifies large transactions.
C) It cannot be used internationally.
D) It has no transaction-related benefits.

Answer: B) It simplifies large transactions.

Explanation: Credit money facilitates transactions, especially those involving large sums, without the
need for physical cash.

21. What does the term "fiat money" refer to?

A) Money backed by physical commodities

B) Currency without intrinsic value, established as money by government decree
C) Money that can be exchanged for gold or silver
D) Digital currency

Answer: B) Currency without intrinsic value, established as money by government decree

Explanation: Fiat money has value because a government maintains it and people have faith in its value.

22. What is the primary problem with using commodity money?

A) It is always in surplus.
B) It can be difficult to transport and heavy to carry.
C) It is accepted only locally.
D) It is too valuable to use in everyday transactions.

Answer: B) It can be difficult to transport and heavy to carry.

Explanation: As trade increases, commodity money can become impractical due to its weight and bulk.

23. What does the "Chicago approach" to measuring money include?

A) Only currency and demand deposits

B) Currency, demand deposits, saving deposits, and time deposits
C) Only physical coins
D) All forms of barter

Answer: B) Currency, demand deposits, saving deposits, and time deposits

Explanation: The Chicago approach broadens the definition of money to include various forms of
deposits.

24. Which measurement approach assigns weights to different assets based on their substitutability?

A) Conventional approach
B) Central Bank approach
C) Chicago approach
D) Gurley-Shaw approach

Answer: D) Gurley-Shaw approach

Explanation: This approach evaluates the degree of substitution among different forms of money and
assigns weights accordingly.

25. What is the primary role of the payments system?

A) To eliminate all forms of cash

B) To facilitate the transfer of money and settle debts
C) To standardize the value of all goods
D) To ensure all transactions are conducted in cash

Answer: B) To facilitate the transfer of money and settle debts

Explanation: The payments system enables smooth transactions and the settlement of debts in a
modern economy.

26. What is a disadvantage of using checks as a form of money?

A) They are not accepted everywhere.

B) They can be easily lost or stolen.
C) They take time to clear through banks.
D) They require carrying large amounts of currency.

Answer: C) They take time to clear through banks.

Explanation: Checks can take several business days to process, which can delay access to funds.

27. What is "credit money" primarily used for?

A) Immediate cash transactions

B) Large transactions without physical cash
C) Storing wealth
D) Bartering

Answer: B) Large transactions without physical cash

Explanation: Credit money facilitates larger transactions, allowing for easier transfers without cash.

28. How does electronic money improve the payments system?

A) By requiring physical currency

B) By eliminating transaction delays
C) By making payments less secure
D) By increasing reliance on cash

Answer: B) By eliminating transaction delays

Explanation: Electronic means of payment streamline transactions, making them faster and more
efficient.

29. What is a key characteristic of metallic money?

A) It is easily perishable.
B) It is made from various metals, primarily gold and silver.
C) It cannot be standardized.
D) It requires no government backing.

Answer: B) It is made from various metals, primarily gold and silver.

Explanation: Metallic money refers to coins made from metals, which are durable and easy to transport.

30. What does the term "liquidation of wealth" refer to in the context of money?

A) Converting non-cash assets into cash

B) Storing wealth in physical form
C) Distributing wealth evenly
D) Abolishing all forms of wealth

Answer: A) Converting non-cash assets into cash

Explanation: Liquidation of wealth means turning assets into cash, which can be easily used for
transactions.

31. What is a major advantage of paper money over metallic money?

A) It is heavier and harder to steal.

B) It is easier to carry and lighter.
C) It has intrinsic value.
D) It can be used for larger transactions only.

Answer: B) It is easier to carry and lighter.

Explanation: Paper money is much lighter than coins, making it more convenient for everyday
transactions.

32. Which of the following is a disadvantage of using commodity money?

A) It is easy to use.
B) It can be difficult to store and transport.
C) It is valued universally.
D) It is always readily available.

Answer: B) It can be difficult to store and transport.

Explanation: Commodity money can be cumbersome due to its bulk and weight, especially when trading
large amounts.

33. What does "M1" represent in the measurement of money?

A) Currency and time deposits

B) Currency and demand deposits
C) Currency, demand deposits, and savings
D) All forms of credit

Answer: B) Currency and demand deposits

Explanation: M1 includes currency in circulation and demand deposits, which are accessible for
immediate use.

34. What is the historical significance of the barter system?

A) It was the first form of currency.

B) It laid the groundwork for the development of money.
C) It eliminated the need for trade.
D) It was more efficient than money.

Answer: B) It laid the groundwork for the development of money.

Explanation: The barter system highlighted the need for a more efficient medium of exchange, leading
to the creation of money.

35. What does the term "electronic means of payment" include?

A) Only cash transactions

B) Digital transactions such as credit cards and mobile payments
C) Barter transactions
D) Checks and drafts

Answer: B) Digital transactions such as credit cards and mobile payments

Explanation: Electronic means of payment refers to transactions conducted through digital platforms,
enhancing efficiency.

36. How did the introduction of coinage improve the monetary system?

A) It made all forms of money obsolete.

B) It standardized the form and value of money.
C) It eliminated the need for barter.
D) It increased the weight of money.

Answer: B) It standardized the form and value of money.

Explanation: Coinage allowed for a consistent medium of exchange, making transactions simpler and
more reliable.

37. What role does money play in facilitating specialization?

A) It reduces the need for trade.
B) It allows individuals to focus on their comparative advantages.
C) It eliminates market competition.
D) It prohibits investment in various sectors.

Answer: B) It allows individuals to focus on their comparative advantages.

Explanation: Money enables people to specialize in what they do best, improving overall economic
efficiency.

38. What does the "store of value" function imply about money?

A) It must be physical goods.

B) It retains purchasing power over time.
C) It is only valuable in the short term.
D) It is not useful for future transactions.

Answer: B) It retains purchasing power over time.

Explanation: Money serves as a means to save purchasing power for future use, although it can lose
value during inflation.

39. How does credit money facilitate economic transactions?

A) It requires physical transfer of cash.

B) It simplifies large transactions without cash.
C) It limits the ability to transact.
D) It encourages barter.

Answer: B) It simplifies large transactions without cash.

Explanation: Credit money allows for large transactions to occur without the need for physical cash,
improving efficiency.

40. What is a disadvantage of using checks as a form of payment?

A) They can be easily lost.

B) They are universally accepted.
C) They are difficult to write.
D) They require immediate cash.

Answer: A) They can be easily lost.

Explanation: While checks are convenient, they can be lost or stolen, posing a risk to users.

41. What is the role of the Central Bank approach in measuring money supply?
A) It defines money very narrowly.
B) It includes a broad view of money, including credit.
C) It excludes all forms of credit.
D) It focuses only on physical currency.

Answer: B) It includes a broad view of money, including credit.

Explanation: The Central Bank approach encompasses various forms of money and credit to assess the
overall money supply.

42. What does the term "liquidity" refer to in the context of money?

A) The ability to convert assets into cash quickly

B) The physical weight of money
C) The value of money over time
D) The variety of currencies available

Answer: A) The ability to convert assets into cash quickly

Explanation: Liquidity refers to how easily an asset can be converted into cash without losing value.

43. What does "M2" include in the context of measuring money supply?

A) Only physical currency

B) Currency, demand deposits, savings deposits, and time deposits
C) Only demand deposits
D) Currency and credit

Answer: B) Currency, demand deposits, savings deposits, and time deposits

Explanation: M2 is a broader measure of the money supply that includes various forms of money that
are readily accessible.

44. Which of the following is a characteristic of electronic money?

A) It requires physical transport.

B) It is less secure than cash.
C) It allows for instant transactions.
D) It is not widely accepted.

Answer: C) It allows for instant transactions.

Explanation: Electronic money facilitates immediate transactions through digital platforms, enhancing
convenience.

45. What is a key challenge of using commodity money?

A) It has intrinsic value.
B) It is easy to transport.
C) It can be difficult to standardize.
D) It is always in demand.

Answer: C) It can be difficult to standardize.

Explanation: Commodity money's value can vary, making standardization a challenge in trade.

46. How does money contribute to economic efficiency?

A) By eliminating all forms of trade

B) By enabling specialization and reducing transaction costs
C) By creating barriers to entry in markets
D) By promoting government control of resources

Answer: B) By enabling specialization and reducing transaction costs

Explanation: Money allows individuals to focus on their strengths and reduces the costs associated with
trading goods and services.

47. What does the term "double coincidence of wants" refer to in barter?

A) The need for two people to want each other's goods simultaneously
B) The ability to trade without a medium of exchange
C) The requirement for equal value in trades
D) The necessity of cash in transactions

Answer: A) The need for two people to want each other's goods simultaneously
Explanation: In barter, both parties must desire what the other has, making transactions complex.

48. What is a significant advantage of using paper money?

A) It has intrinsic value.

B) It is lighter and easier to carry than coins.
C) It is universally trusted.
D) It can be used
 CHAPTER 2
1 What is asset?

A) A temporary liability
B) Anything of durable value that stores value over time
C) A form of currency
D) A short-term investment

Answer: B) Anything of durable value that stores value over time

Explanation: An asset is defined as something that has lasting value and can be used to store wealth.

2. What are real assets?

A) Claims against other assets

B) Financial assets in physical form
C) Digital currencies
D) Intangible assets

Answer: B) Financial assets in physical form

Explanation: Real assets include tangible items like land, equipment, and buildings, as well as human
capital.

3. What is the definition of financial assets?

A) Physical goods like land and buildings

B) Claims against real assets
C) Only cash
D) Personal property

Answer: B) Claims against real assets

Explanation: Financial assets represent a claim on real assets, which can be either direct or indirect.

4. Which of the following best describes securities?

A) Only government-issued bonds

B) Financial assets exchanged in regulated markets
C) Only stocks traded on exchanges
D) Any form of currency

Answer: B) Financial assets exchanged in regulated markets

Explanation: Securities include various financial instruments that are traded in legal markets, subject to
regulations.
5. Who are lenders in financial markets?

A) Those who borrow money

B) Those who have excess funds to loan out
C) Those who invest in stocks
D) Those who issue bonds

Answer: B) Those who have excess funds to loan out

Explanation: Lenders are individuals or institutions with surplus funds seeking to lend them to
borrowers.

6. What is the primary function of financial markets?

A) To create new assets

B) To channel funds between lenders and borrowers
C) To regulate interest rates
D) To eliminate risks in investments

Answer: B) To channel funds between lenders and borrowers

Explanation: Financial markets facilitate the borrowing and lending process, connecting those with
funds to those in need of funds.

7. What characterizes the debt market?

A) Trading of equity instruments

B) Trading of financial instruments requiring fixed payments
C) Market for real assets
D) Trading of intangible assets

Answer: B) Trading of financial instruments requiring fixed payments

Explanation: The debt market involves instruments like bonds that obligate issuers to make fixed
payments to holders.

8. What is a money market?

A) A market for long-term investments

B) A market for financial instruments with maturities of one year or less
C) A market focused on real assets
D) A market for commodity trading

Answer: B) A market for financial instruments with maturities of one year or less
Explanation: The money market deals with short-term financial instruments, allowing for quick access to
funds.
9. Which of the following is an example of a capital market instrument?

A) Treasury bills
B) Savings accounts
C) Corporate bonds
D) Commercial paper

Answer: C) Corporate bonds

Explanation: Capital market instruments include long-term securities, such as corporate bonds, which
mature in more than one year.

10. What distinguishes the primary market from the secondary market?

A) Primary market involves existing securities, while secondary market involves newly issued securities
B) Primary market involves newly issued securities, while secondary market involves existing securities
C) Primary market is unregulated, while secondary market is regulated
D) Primary market deals only with stocks, while secondary market deals only with bonds

Answer: B) Primary market involves newly issued securities, while secondary market involves existing
securities
Explanation: The primary market is where new securities are issued, while the secondary market is
where previously issued securities are traded.

11. What is the role of financial intermediaries?

A) To eliminate borrowing
B) To link lenders and borrowers
C) To create new currencies
D) To manage government funds

Answer: B) To link lenders and borrowers

Explanation: Financial intermediaries facilitate the flow of funds from those with surplus to those with
deficits.

12. What is one function of financial markets?

A) To increase transaction costs

B) To determine the price of traded financial assets
C) To eliminate competition
D) To restrict access to funds
Answer: B) To determine the price of traded financial assets
Explanation: Financial markets allow the price of securities to be set through the interaction of supply
and demand.

13. What is the definition of direct finance?

A) Borrowers obtain funds indirectly through intermediaries

B) Borrowers raise funds directly from lenders
C) Funds are provided by the government
D) All transactions are conducted in cash

Answer: B) Borrowers raise funds directly from lenders

Explanation: In direct finance, borrowers obtain funds directly from lenders by issuing financial
instruments.

14. What is an example of a money market instrument?

A) Stocks
B) Treasury bills
C) Corporate bonds
D) Real estate

Answer: B) Treasury bills

Explanation: Treasury bills are short-term instruments used in the money market.

15. What do the terms "nominal interest rate" and "real interest rate" refer to?

A) Nominal is adjusted for inflation; real is not

B) Real is adjusted for inflation; nominal is not
C) Both are adjusted for inflation
D) Both are not adjusted for inflation

Answer: B) Real is adjusted for inflation; nominal is not

Explanation: The nominal interest rate does not account for inflation, while the real interest rate does.

16. How is the present value of future income calculated?

A) By multiplying future income by the interest rate

B) By discounting future income back to today's value
C) By adding future income to current assets
D) By dividing future income by inflation rate
Answer: B) By discounting future income back to today's value
Explanation: Present value calculations involve discounting future cash flows to determine their value
today.

17. What is the Fisher equation?

A) States that money supply equals demand

B) Relates nominal interest rates to real interest rates and inflation
C) Indicates the relationship between assets and liabilities
D) Describes the behavior of financial markets

Answer: B) Relates nominal interest rates to real interest rates and inflation
Explanation: The Fisher equation shows how nominal interest rates are composed of real rates plus
expected inflation.

18. What is the primary characteristic of equity securities?

A) They represent a loan to a corporation

B) They provide a claim on the earnings and assets of a corporation
C) They are always risk-free
D) They do not fluctuate in value

Answer: B) They provide a claim on the earnings and assets of a corporation

Explanation: Equity securities, such as stocks, give holders a claim on a company's assets and profits.

19. What is the function of the call money market?

A) To provide funds for long-term investments

B) To facilitate overnight borrowing among banks
C) To support government financing
D) To stabilize currency values

Answer: B) To facilitate overnight borrowing among banks

Explanation: The call money market allows banks to borrow and lend funds on a short-term basis,
typically overnight.

20. What is the main advantage of using credit money?

A) It requires physical cash for transactions

B) It simplifies large transactions
C) It has no associated risks
D) It is always available
Answer: B) It simplifies large transactions
Explanation: Credit money allows large transactions to occur without the need for physical cash, making
it more efficient.

21. What does "store of value" mean in the context of money?

A) The ability to accumulate wealth

B) The ease of spending money
C) The capacity to retain purchasing power over time
D) The potential for investment growth

Answer: C) The capacity to retain purchasing power over time

Explanation: A store of value means that money can be saved and will hold its value for future use.

22. Which of the following represents an example of indirect finance?

A) A person lending money to a friend

B) A bank loaning money to a business
C) A government issuing bonds
D) A company selling shares directly to the public

Answer: B) A bank loaning money to a business

Explanation: In indirect finance, financial intermediaries like banks facilitate loans between savers and
borrowers.

23. What is a key disadvantage of using paper currency?

A) It is difficult to transport.
B) It can be easily stolen or damaged.
C) It has high transaction costs.
D) It is not widely accepted.

Answer: B) It can be easily stolen or damaged.

Explanation: Paper currency is susceptible to theft and can deteriorate, making it less secure than other
forms of money.

24. What are derivatives?

A) Financial instruments representing ownership

B) Contracts based on the value of underlying assets
C) Only government-issued securities
D) Cash equivalents
Answer: B) Contracts based on the value of underlying assets
Explanation: Derivatives are financial contracts whose value is derived from the performance of
underlying assets.

25. What is the primary role of financial markets in an economy?

A) To eliminate risk
B) To facilitate the allocation of resources
C) To regulate government spending
D) To control inflation

Answer: B) To facilitate the allocation of resources

Explanation: Financial markets help in directing funds to their most productive uses, enhancing
economic efficiency.

26. Which market deals with long-term financial instruments?

A) Money Market
B) Capital Market
C) Commodity Market
D) Foreign Exchange Market

Answer: B) Capital Market

Explanation: The capital market is where long-term financial instruments, such as stocks and bonds, are
traded.

27. What is the purpose of the money market?

A) To trade long-term investments

B) To manage short-term funding needs
C) To facilitate international trade
D) To stabilize currency values

Answer: B) To manage short-term funding needs

Explanation: The money market is used for short-term financial instruments, typically with maturities of
one year or less.

28. Which type of financial intermediary is most important in the monetary system?

A) Non-bank financial institutions

B) Investment funds
C) Banking institutions
D) Government agencies
Answer: C) Banking institutions
Explanation: Banks are crucial as they facilitate the transfer of funds between savers and borrowers in
the economy.

29. What is the role of financial intermediaries in risk sharing?

A) They eliminate all risks in the market.

B) They transfer risks from investors to borrowers.
C) They help distribute risk among various parties.
D) They increase the level of risk for investors.

Answer: C) They help distribute risk among various parties.

Explanation: Financial intermediaries allow for the spreading of investment risks across many
participants in the market.

30. What is a characteristic of organized exchanges?

A) They require decentralized trading.

B) They have no physical location.
C) They provide a centralized location for trading securities.
D) They operate without regulations.

Answer: C) They provide a centralized location for trading securities.

Explanation: Organized exchanges offer a structured environment where buyers and sellers can meet to
trade securities.
 CHAPTER 3
Questions and Answers

1. What does the Quantity Theory of Money primarily discuss?

A) The rates of inflation

B) The relationship between money supply and aggregate income
C) The history of financial markets
D) The types of financial instruments

Answer: B) The relationship between money supply and aggregate income

Explanation: The Quantity Theory of Money explains how the nominal value of aggregate income
is determined by the money supply.

2. What is the velocity of money?

A) The speed of currency circulation

B) The total value of goods produced
C) The rate of turnover of money
D) The amount of money in circulation

Answer: C) The rate of turnover of money

Explanation: Velocity of money refers to how many times a unit of currency is spent in an economy over
a period.

3. According to classical economists, what affects the velocity of money?

A) Government regulations
B) Institutional and technological factors
C) Market demand
D) Consumer preferences

Answer: B) Institutional and technological factors

Explanation: Classicalists believe that the velocity of money is influenced by how institutions and
technologies affect payment behavior.

4. If the money supply doubles, what happens to nominal income according to the Quantity Theory?

A) It remains unchanged
B) It doubles
C) It decreases
D) It becomes unpredictable
Answer: B) It doubles
Explanation: If velocity is constant, any change in money supply will directly affect nominal income
proportionally.

5. What does the Quantity Theory assume about aggregate real income in the short run?

A) It is highly variable
B) It will remain constant
C) It will increase significantly
D) It will decrease

Answer: B) It will remain constant

Explanation: The theory assumes that real income is stable at the equilibrium level in the short run.

6. What is the main conclusion of the Quantity Theory of Money regarding inflation?

A) Inflation is independent of money supply

B) Inflation results solely from changes in the quantity of money
C) Inflation only occurs in developing economies
D) Inflation is a result of interest rate changes

Answer: B) Inflation results solely from changes in the quantity of money

Explanation: The theory posits that changes in money supply directly lead to changes in the price level.

7. What do the Cambridge economists emphasize regarding money demand?

A) Money demand is only affected by inflation

B) Money demand is a function of nominal income
C) Money demand is solely determined by interest rates
D) Money demand is unrelated to wealth

Answer: B) Money demand is a function of nominal income

Explanation: The Cambridge approach states that money demand depends on a proportion of nominal
income.

8. Which motive for holding money does Keynes identify that is not affected by interest rates?

A) Transaction motive
B) Precautionary motive
C) Speculative motive
D) All of the above
Answer: A) Transaction motive
Explanation: Keynes noted that the transaction motive for holding money is not influenced by interest
rates.

9. What does the speculative motive for holding money consider?

A) Only current expenses

B) Future liquidity needs
C) Relative returns on assets and risk
D) Government regulations

Answer: C) Relative returns on assets and risk

Explanation: The speculative motive involves weighing the expected returns of money against other
assets, considering risk.

10. How does Tobin's approach differ from Keynes regarding speculative demand for money?

A) Tobin ignores interest rates

B) Tobin emphasizes risk and diversification
C) Tobin does not consider the speculative motive
D) Tobin believes in fixed returns

Answer: B) Tobin emphasizes risk and diversification

Explanation: Tobin introduced the idea that individuals consider risk when choosing which assets to
hold.

11. What does Friedman suggest about the demand for money?

A) It is solely determined by transaction costs

B) It is influenced by the same factors affecting all assets
C) It is completely insensitive to interest rates
D) It fluctuates wildly with economic cycles

Answer: B) It is influenced by the same factors affecting all assets

Explanation: Friedman argued that the demand for money is affected by wealth and the expected
returns on substitute assets.

12. What is meant by "permanent income" in Friedman's theory?

A) Average income over a short term

B) Expected long-run average income
C) Current income only
D) Income from speculative investments
Answer: B) Expected long-run average income
Explanation: Permanent income refers to the average income that individuals expect to earn over the
long term, smoothing out fluctuations.

13. In Friedman's model, what happens to the demand for money when the interest rate on bonds
rises?

A) Demand for money increases

B) Demand for money decreases
C) Demand for money remains unchanged
D) Demand for bonds increases but not for money

Answer: B) Demand for money decreases

Explanation: As the expected return on bonds increases, individuals are likely to shift their holdings
away from money.

14. What is a liquidity trap?

A) High interest rates

B) Low demand for money
C) When monetary policy becomes ineffective at lowering interest rates
D) A situation where all money is tied up in investments

Answer: C) When monetary policy becomes ineffective at lowering interest rates

Explanation: A liquidity trap occurs when interest rates are low and savings rates are high, making
monetary policy ineffective.

15. According to the Quantity Theory, what happens when economic output increases?

A) Money supply must remain constant

B) Velocity of money increases
C) Nominal income will also increase
D) Interest rates will rise

Answer: C) Nominal income will also increase

Explanation: If the money supply increases while output also grows, nominal income rises accordingly.

16. What is the relationship between interest rates and money demand in Keynesian theory?

A) Directly proportional
B) Inversely proportional
C) No relationship
D) Varies by asset type
Answer: B) Inversely proportional
Explanation: Keynesian theory suggests that as interest rates rise, the demand for money falls because
people prefer interest-bearing assets.

17. Which of the following best describes the speculative motive?

A) Holding money for immediate transactions

B) Holding money for future unexpected needs
C) Holding money based on expected returns of alternatives
D) Holding money to avoid inflation

Answer: C) Holding money based on expected returns of alternatives

Explanation: The speculative motive involves choosing to hold money based on its risk-free nature
compared to other investments.

18. What does the term "trade-off" in the context of money demand refer to?

A) Balancing income and expenses

B) Choosing between liquidity and return on investments
C) Deciding whether to save or spend
D) Comparing different forms of money

Answer: B) Choosing between liquidity and return on investments

Explanation: Individuals must decide how much money to hold versus investing it for returns, weighing
liquidity against potential earnings.

19. What is the implication of Friedman's demand function for money?

A) Money demand is highly volatile

B) Money demand is stable and predictable
C) Money demand is irrelevant to economic cycles
D) Money demand is only affected by inflation

Answer: B) Money demand is stable and predictable

Explanation: Friedman believed that the demand for money could be predicted accurately using his
money demand function, which incorporates wealth and expected returns.

20. What is the significance of the Fisher equation in money demand?

A) It describes the relationship between money and inflation

B) It relates nominal interest rates to real interest rates and expected inflation
C) It defines the demand for commodity money
D) It outlines the functions of financial markets
Answer: B) It relates nominal interest rates to real interest rates and expected inflation
Explanation: The Fisher equation expresses how nominal interest rates are composed of real rates plus
expected inflation.

21. What role do financial intermediaries play in the economy?

A) They eliminate interest rates

B) They facilitate the flow of funds between savers and borrowers
C) They control the money supply
D) They set interest rates

Answer: B) They facilitate the flow of funds between savers and borrowers
Explanation: Financial intermediaries connect those with surplus funds to those in need of funds,
enhancing market efficiency.

22. What does the term "liquidity preference" imply?

A) People prefer to hold assets with lower returns

B) People prefer assets that can be quickly converted to cash
C) People avoid holding cash entirely
D) People favor long-term investments over cash

Answer: B) People prefer assets that can be quickly converted to cash

Explanation: Liquidity preference indicates a desire to hold cash or cash-equivalent assets for immediate
use.

23. In what scenario would the demand for money be considered "ultra-sensitive" to interest rates?

A) When interest rates are extremely high

B) When the economy is in a recession
C) At minimum interest rates
D) When inflation is rising

Answer: C) At minimum interest rates

Explanation: Demand for money is more sensitive at low interest rates because people are less inclined
to forgo liquidity for investment returns.

24. What is a key assumption of the Quantity Theory of Money regarding velocity?

A) It is highly variable
B) It is constant in the short run
C) It increases with economic growth
D) It decreases with inflation
Answer: B) It is constant in the short run
Explanation: The theory assumes that velocity remains stable in the short term, simplifying the
relationship between money supply and income.

25. What determines the speculative demand for money according to Keynes?

A) Current income levels

B) Expected returns from alternative assets
C) Transaction costs
D) Government policies

Answer: B) Expected returns from alternative assets

Explanation: The speculative demand for money is influenced by the relative expected returns of money
versus other investments.

26. What is the outcome when interest rates on bonds increase?

A) Demand for money increases

B) Demand for money decreases
C) Demand for bonds decreases
D) Interest rates on money increase

Answer: B) Demand for money decreases

Explanation: Higher returns on bonds make them more attractive compared to holding cash, reducing
demand for money.

27. Which of the following best describes the transaction motive for holding money?

A) Holding money for unexpected future needs

B) Holding money for immediate purchases and payments
C) Holding money for speculative investments
D) Holding money as a long-term savings strategy

Answer: B) Holding money for immediate purchases and payments

Explanation: The transaction motive focuses on the need for money to facilitate current consumption
and transactions.

28. What does "permanent income" help explain in Friedman's theory of money demand?

A) Fluctuations in daily earnings

B) A stable measure of expected long-term income
C) The total assets owned by an individual
D) The immediate cash flow
Answer: B) A stable measure of expected long-term income
Explanation: Permanent income provides a more consistent basis for understanding money demand
compared to transitory income changes.

29. How does the liquidity preference theory view interest rates?

A) As irrelevant to money demand

B) As a payment for parting with liquidity
C) As the primary determinant of savings
D) As fixed and unchanging

Answer: B) As a payment for parting with liquidity

Explanation: The liquidity preference theory considers interest rates as compensation for not using
liquid assets.

30. What is the general consensus on the relationship between interest rates and money demand in
post-Keynesian theory?

A) They are directly proportional

B) They are inversely related
C) They have no relationship
D) They fluctuate independently

Answer: B) They are inversely related

Explanation: Post-Keynesian theory suggests that as interest rates rise, the demand for money
decreases because individuals prefer interest-earning assets
 CHAPTER 4
Questions and Answers

1. What does "money supply" refer to in economics?

A) Total amount of currency in circulation

B) The total amount of money available in an economy at a particular time
C) The amount of money held by the government
D) The total amount of assets held by banks

Answer: B) The total amount of money available in an economy at a particular time

Explanation: Money supply encompasses all forms of money available for use within an economy.

2. Why is money supply considered an important macroeconomic variable?

A) It determines tax rates.

B) It affects interest rates and overall economic well-being.
C) It regulates government spending.
D) It controls inflation directly.

Answer: B) It affects interest rates and overall economic well-being.

Explanation: Changes in the money supply can influence interest rates, inflation, and economic activity,
impacting the financial health of individuals and businesses.

3. What is the velocity of money?

A) The rate at which money is printed

B) The speed of currency transactions
C) The average number of times a unit of currency is spent
D) The amount of money in circulation

Answer: C) The average number of times a unit of currency is spent

Explanation: Velocity measures how quickly money changes hands in an economy.

4. According to classical economists, what factors influence the velocity of money?

A) Market demand
B) Institutional and technological factors
C) Government regulations
D) Consumer preferences
Answer: B) Institutional and technological factors
Explanation: Classicalists believe that factors related to institutions and technology influence how
quickly money circulates.

5. If the money supply doubles, what happens to nominal income, assuming velocity is constant?

A) It decreases
B) It remains unchanged
C) It doubles
D) It becomes unpredictable

Answer: C) It doubles
Explanation: If velocity is constant, a doubling of the money supply will directly double nominal income.

6. What does the Quantity Theory of Money suggest about inflation?

A) It is unrelated to money supply

B) It results solely from changes in the quantity of money
C) It is only caused by external factors
D) It depends on interest rates

Answer: B) It results solely from changes in the quantity of money

Explanation: The theory posits that inflation is directly linked to changes in the money supply.

7. Who are the four main players in the money supply process?

A) Central bank, banks, depositors, borrowers

B) Governments, businesses, consumers, investors
C) Economists, policymakers, banks, consumers
D) Central bank, government, businesses, consumers

Answer: A) Central bank, banks, depositors, borrowers

Explanation: These four entities are crucial in the functioning and regulation of money supply in an
economy.

8. What are the primary assets held by central banks?

A) Stocks and bonds

B) Securities, discount loans, gold, and cash
C) Real estate
D) Commodities
Answer: B) Securities, discount loans, gold, and cash
Explanation: Central banks hold various financial instruments, including government securities, loans to
banks, and reserves.

9. What is the monetary base?

A) The total value of all assets in the economy

B) The amount of currency directly supplied by the central bank
C) The total of all bank deposits
D) The amount of money in circulation

Answer: B) The amount of currency directly supplied by the central bank

Explanation: The monetary base includes currency in circulation and reserves held by banks.

10. What is the formula for calculating the monetary base (MB)?

A) MB = C + D
B) MB = C + R
C) MB = D + R
D) MB = C + D + R

Answer: B) MB = C + R
Explanation: The monetary base is calculated as the sum of currency in circulation (C) and reserves (R)
held by banks.

11. What is the primary method by which central banks control the monetary base?

A) Adjusting tax rates

B) Open market operations
C) Setting interest rates
D) Regulating foreign exchange

Answer: B) Open market operations

Explanation: Central banks primarily influence the monetary base through the buying and selling of
government securities.

12. What happens during an open market purchase by the central bank?

A) The monetary base decreases

B) Reserves in the banking system increase
C) The money supply contracts
D) Interest rates automatically rise
Answer: B) Reserves in the banking system increase
Explanation: When the central bank purchases securities, it adds to the reserves of the banking system.

13. What effect does an open market sale have on the monetary base?

A) It increases the monetary base

B) It decreases the monetary base
C) It has no effect on the monetary base
D) It stabilizes the monetary base

Answer: B) It decreases the monetary base

Explanation: An open market sale reduces the amount of reserves in the banking system and thus
decreases the monetary base.

14. What is the impact of a shift from deposits to currency on the monetary base?

A) It increases the monetary base

B) It decreases the monetary base
C) It has no effect on the monetary base
D) It stabilizes the monetary base

Answer: C) It has no effect on the monetary base

Explanation: While reserves decrease, the total monetary base remains unchanged during such a shift.

15. What is a discount loan?

A) A loan for purchasing securities

B) A loan from the central bank to commercial banks
C) A personal loan from a bank
D) A loan issued by the government

Answer: B) A loan from the central bank to commercial banks

Explanation: Discount loans are provided by the central bank to banks to help them meet reserve
requirements.

16. How does an increase in the required reserve ratio affect the money multiplier?

A) It increases the money multiplier

B) It decreases the money multiplier
C) It has no effect on the money multiplier
D) It makes the money multiplier unpredictable
Answer: B) It decreases the money multiplier
Explanation: A higher required reserve ratio means banks can lend less, resulting in a lower money
multiplier.

17. What does the term "multiple deposit creation" refer to?

A) The process of banks creating new currency

B) The increase in deposits resulting from a change in reserves
C) The reduction of reserves through loans
D) The issuance of bonds by banks

Answer: B) The increase in deposits resulting from a change in reserves

Explanation: Multiple deposit creation occurs when banks lend out more than their initial reserves,
creating new deposits.

18. If a bank has a required reserve ratio of 10%, what is the money multiplier?

A) 5
B) 10
C) 20
D) 100

Answer: B) 10
Explanation: The money multiplier is the reciprocal of the required reserve ratio; thus, 1/0.10 = 10.

19. What happens to the money supply when the central bank increases the monetary base?

A) The money supply decreases

B) The money supply remains the same
C) The money supply increases
D) The money supply becomes unpredictable

Answer: C) The money supply increases

Explanation: An increase in the monetary base typically leads to a proportional increase in the money
supply.

20. How does the liquidity preference theory relate to interest rates?

A) It ignores interest rates completely

B) It states that higher interest rates decrease the demand for money
C) It states that lower interest rates increase the demand for money
D) It suggests that all money is equally liquid
Answer: B) It states that higher interest rates decrease the demand for money
Explanation: According to liquidity preference theory, higher interest rates make holding money less
attractive compared to interest-bearing assets.

21. What is the primary function of the monetary base?

A) To regulate interest rates

B) To serve as collateral for loans
C) To provide currency and reserves in the banking system
D) To measure inflation

Answer: C) To provide currency and reserves in the banking system

Explanation: The monetary base encompasses all currency and reserves available in the economy,
serving as the foundation for the money supply.

22. What is a key characteristic of the money market?

A) It deals with long-term securities

B) It involves short-term debt instruments
C) It is unregulated
D) It focuses on real assets

Answer: B) It involves short-term debt instruments

Explanation: The money market is specifically for short-term financial instruments with maturities of
one year or less.

23. How does the Central Bank influence the economy?

A) By controlling fiscal policy

B) Through open market operations and interest rates
C) By regulating trade
D) By imposing taxes

Answer: B) Through open market operations and interest rates

Explanation: The Central Bank influences monetary policy and economic conditions primarily via these
methods.

24. What happens to the money supply when the central bank conducts an open market sale?

A) It increases
B) It remains unchanged
C) It decreases
D) It becomes unpredictable
Answer: C) It decreases
Explanation: An open market sale reduces the monetary base and subsequently the money supply.

25. What do excess reserves allow banks to do?

A) Increase their loans

B) Decrease their interest rates
C) Stabilize the monetary base
D) Eliminate transaction costs

Answer: A) Increase their loans

Explanation: Excess reserves are funds that banks can use to make additional loans, expanding the
money supply.

26. What effect does a rise in the currency ratio (C/D) have on the money multiplier?

A) It increases the money multiplier

B) It decreases the money multiplier
C) It has no effect
D) It stabilizes the money multiplier

Answer: B) It decreases the money multiplier

Explanation: An increase in the currency ratio indicates more money is held as cash rather than
deposits, reducing the potential for deposit expansion.

27. What happens to the money supply if the required reserve ratio is lowered?

A) Money supply decreases

B) Money supply remains unchanged
C) Money supply increases
D) Money supply becomes unpredictable

Answer: C) Money supply increases

Explanation: Lowering the required reserve ratio allows banks to lend more of their deposits, increasing
the money supply.

28. What do T-accounts represent in banking?

A) The overall financial health of the economy

B) The balance sheets of banks showing assets and liabilities
C) The interest rates set by the central bank
D) The liquidity of financial markets
Answer: B) The balance sheets of banks showing assets and liabilities
Explanation: T-accounts illustrate the financial position of banks, detailing their assets and liabilities.

29. What does the term "float" refer to in the context of the central bank?

A) Extra currency issued by the government

B) Temporary discrepancies in the banking system's reserves
C) Long-term investments held by the central bank
D) The total amount of money in circulation

Answer: B) Temporary discrepancies in the banking system's reserves

Explanation: Float represents the time delay in processing checks, affecting the reserves of banks.

30. In the context of money demand, what does "liquidity preference" indicate?

A) People prefer to hold cash over other assets

B) People prefer to invest in stocks
C) People avoid holding cash due to interest rates
D) People desire to hold assets that are less liquid

Answer: A) People prefer to hold cash over other assets

Explanation: Liquidity preference refers to the tendency of individuals to prefer holding liquid assets
(cash) for immediate transactions.