The Diagrams Below Illustrate Two Alternative Approaches to Implementing Monetary

question 35

Multiple Choice

The diagrams below illustrate two alternative approaches to implementing monetary policy. The economy begins in monetary equilibrium with the interest rate equal to 2% and the money supply equal to M0.
FIGURE 28-1
-Refer to Figure 28-1. If the Bank of Canadaʹs goal is to increase the target interest rate from 2% to 3%, then the most effective approach is to

• A) reduce the money supply to M1, as shown in part ii), and then let the interest rate adjust to 3%.
• B) increase the money supply to M1, as shown in part ii), and then let the interest rate adjust to 3%.
• C) allow the money supply to shift to M1 by market forces, which will cause the interest rate to rise to 3%.
• D) raise the interest rate to 3%, as shown in part i), and then buy government securities in financial markets to accommodate the decline in the quantity of money demanded.
• E) raise the interest rate to 3%, as shown in part i), and then sell government securities in financial markets to accommodate the decline in the quantity of money demanded.

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Definitions:

Consumer Surplus

The gulf between the aggregate amount consumers are willing to allocate for a good or service and what they actually end up paying.

Producer Surplus

The variance between the minimum amount producers are prepared to take for a product and the actual payment they get.

Opportunity Cost

The cost of forgoing the next best alternative when making a decision or choosing between multiple options.

Deadweight Loss

The loss of economic efficiency that occurs when the equilibrium for a good or service is not achieved, often due to market distortions like taxes or subsidies.