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Economics 110B
Solutions to Practice Questions for Chapter 14
1)
Let
i
= the nominal interest rate and let
r
= the real interest rate.
If an individual borrows one dollar today, the individual is expected to repay 1 +
i
dollars
in the future.
Thus, the nominal interest rate represents the cost of borrowing dollars in
terms of dollars repaid.
Alternatively, if an individual borrows one unit of a good today, the individual is expected
to repay 1 +
r
units of the good in the future.
Thus, the real interest rate represents the cost
of borrowing goods in terms of goods repaid.
2)
The nominal interest rate is determined in financial markets. The real interest rate,
r
, is
e
r
i
π
≈ 
, where
i
= nominal interest rate and
e
= expected inflation. When
i
increases,
the real interest rate can fall if the increase in expected inflation is greater than the increase
in the nominal interest rate.
3)
An increase in money growth will cause the LM curve to shift down.
This will lower the
nominal interest rate.
Assuming expected inflation does not change, the real interest rate
will fall by the same amount.
Investment will increase causing an increase in demand and
output.
(See graph on page 3 of solutions).
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This note was uploaded on 05/01/2011 for the course ECON 110B taught by Professor Peters during the Spring '07 term at UCSD.
 Spring '07
 Peters
 Economics, Macroeconomics

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