Economics 101: Analyzing Monetary Policy and Demand Elasticity Exam

This document provides a comprehensive solution to an economics exam, addressing key concepts in monetary policy and demand elasticity. The first question delves into monetary policy, specifically examining the tools employed by the UK central bank, including bank rate, repo rate, reserve repo rate, and quantitative easing (QE). It explains how these tools influence the money supply and impact the economy, including inflation and deflation scenarios. The second question focuses on elasticity of demand, particularly cross-price elasticity and its implications for complementary goods. It analyzes the relationship between peanut butter and grape jelly, illustrating how changes in the price of one good affect the demand for the other. The solution explains how the price increase of peanut butter would decrease demand for both peanut butter and grape jelly. The document also includes references to relevant academic sources.

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Table of Contents
QUESTIONS .................................................................................................................................3
3...................................................................................................................................................3
5...................................................................................................................................................4
REFERENCES...............................................................................................................................1

QUESTIONS
3.
Monetary policy are the policy which is formulated by the central government and
control the money supply in the country. Central government influence the money supply in
economy and cost to borrow it. UK central bank uses the main 2 monetary policy in the country
which are interest Bank rate and Quantitative easing.
Bank Rate is the rate which is the interest rate paid by commercial bank to central bank
that hold the money. Bank changes there interest rate when the central bank changes the rate of
lending the money. Higher the interest rate change by commercial bank when there is an
inflation in the country (Auer and Papies, 2020). When the economy is at inflation point with
high supply of money, central bank increase the bank rate in the country that result in expensive
borrowing and leads to downfall in inflation and back to balance economy. Whereas, is the
economy is faces the deflation in country with low supply of money, bank rate is charge low by
the central bank and commercial bank which results in more borrowing and lending of money
that brings the deflation period to balanced point in country.
Repo rate is the rate which is given by the central bank to commercial bank when there
is excess of money supply in market. Commercial banks lend their excess money to central bank
and interest rate is given to commercial bank is high, If the country is facing huge deflation and
crises in the economy, central bank give less interest rate on borrowing money to commercial
bank (Gregor and Melecký, 2018).
Reserve repo rate is the rate where the commercial bank deposit excess money to
central bank where commercial bank is given interest on the money deposited. This is done
when there is excess of money supply in the market and if the there is deflation in the market the
rate is very low in market.
Quantitative easing is the tool of central bank which used to inject money directly in
the economy of UK. Money is either in the form of physical I.e. banknote or in the digital form
I.e. in the money in bank account. This tool involves to create digital money and further used to
purchase government bonds (Huh and Infante, 2017). This is also known as assets purchase. The
tool is used to boost the economy by increase the spending and investment of people. This is
done through large scale of purchasing of government bond with lower interest rate which result
in low interest rate are offered on loans like mortgage loan or business loan which affect the

government bonds and interest rate in the economy. QE help people top borrow money from the
government in cheaper rates for household and businesses and encourage their spending
(Méndez-Carbajo and Asarta, 2017). Quantitative easing can bring balance in the economy by
boosting the wide range of financial assets price in country.
5.
a) Elasticity of demand measures the responsiveness of demand of a particular good or service
due to corresponding change in price of that good or service. In case of cross – price elasticity of
demand which is a measure of responsiveness in case of goods which are related with each other
in some sense like either they may be substitutes or complementary of each other (Méndez-
Carbajo and Asarta, 2017). Here it is given that the cross – price elasticity of demand between
peanut butter and grape jelly is negative which indicate that these two goods are related to each
other and there is a negative relationship lies between the two. Such negative relationship
indicate that when price of peanut butter will change then there will be negative impact on the
demand for grape jelly. For example, if the price will rise of peanut butter then there will be
decrease in demand of grape jelly (Gostkowski, 2018). Due to this negative relationship between
both these goods, these goods are considered as complementary goods. The reason behind such
consideration is that these goods are pair goods and usually consumed together. There individual
relevancy decreases due to the absence of another. As we know that when the price of peanut
butter increase, the customers are unable to buy them and accordingly this change will impact
the demand for grape jelly in the sense that it will be decrease because as consumers will not
buy expensive peanut butter.
b) Here it is given that the price of peanut butter is increasing, so the effect on demand of both
the peanut butter and grape jelly would be as follows:
If the price of peanut butter will increase then as per the law of demand which states that
there is an inverse relationship between price and demand of the goods and services, which
means that when price of the good increases this will decrease the demand of the good and
opposite is the case when price of the goods service falls (Auer and Papies, 2020). So, in case of
rising price of peanut butter, there will be decrease in demand for peanut butter. This is due to
the fact that other things remains constant which includes the income of the consumer, so the

constancy in income will reduce the scope for consumers to buy peanut butter at its increased
price (Ghoddusi and Roy, 2018).
The another effect which will be reflected due to increase in price of peanut butter is on
the demand of its related good which can either be its substitute or complementary. If it is
substitute then the demand will increase and if it is complementary then the demand will
decrease. Here it is given that the cross – price elasticity of demand between both of these
products is negative, so this indicate that these goods are complementary. In case of
complementary goods, when price of a particular good rises then the demand for goods which
are complementary to it will be decreased. Thus, the effect of price rise of peanut butter will
result in reduction in demand of both peanut butter and its complementary grape jelly.

REFERENCES
Books and journals
Auer, J. and Papies, D., 2020. Cross-price elasticities and their determinants: A meta-analysis
and new empirical generalizations. Journal of the Academy of Marketing Science, pp.1-
22.
Ghoddusi, H. and Roy, M., 2018. Income Elasticity of Demand Versus Income Elasticity of
Consumption. Available at SSRN 3122844.
Gostkowski, M., 2018. Elasticity of consumer demand: estimation using a quadratic almost ideal
demand system. Econometrics, 22(1), pp.68-78.
Gregor, J. and Melecký, M., 2018. The pass-through of monetary policy rate to lending rates:
The role of macro-financial factors. Economic Modelling, 73. pp.71-88.
Huh, Y. and Infante, S., 2018. Bond market intermediation and the role of repo. Available at
SSRN 2773678.
Lee, J., 2017. Collateral circulation and repo spreads. Available at SSRN 2548209.
Méndez-Carbajo, D. and Asarta, C. J., 2017. Using FRED data to teach price elasticity of
demand. The Journal of Economic Education, 48(3), pp.176-185.
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