Hehe

[pic]


The Demand for Money

1. Define what economists mean by the term interest rate.

The interest rate is the annual interest payment on a loan expressed as a percentage of the loan. Equal to the amount of interest received per year divided by the amount of the loan.

Difficulty: E Type: D

2. In broad terms what is monetary policy?

Monetary policy is thebehavior of the Federal Reserve regarding the money supply.

Difficulty: E Type: D

3. What are the two major forces that determine the demand for money?

The two major forces that determine the demand for money are the interest rate and the dollar volume of transactions. The latter is a function of aggregate output and the price level.

Difficulty: E Type: F

4. Onerationale for holding money is the transaction motive. Explain what this means.

The transaction motive is the main reason that people hold money – to buy things.

Difficulty: E Type: C

5. What is meant by the nonsynchronization of income and spending?

Nonsynchronization is the mismatch between the timing of money inflow to the household and the timing of money outflow forhousehold expenses.

Difficulty: E Type: C

6. Assume that Joe earns $2400 a month, deposits it in a checking account and draws down his income evenly throughout the course of the month with an average money holding of $1200. What are the costs of this money strategy?

What is wrong with this strategy is that Joe is giving up interest on his funds, interest he could be earning if heheld some of his funds in interest-bearing bonds instead of in his checking account.


Difficulty: E Type: D

7. Assume that the interest rate paid on bonds rises from 4% to 6%. Explain what would happen to the level of optimal (money) balances.

Optimal balances would decrease because it opportunity cost of holding money goes up.

Difficulty: E Type: D

8. Explainbriefly what the optimal balance of money strategy is.

It is the level of average money balances that earn the most profit taking into account both the interest earned on bonds and the costs paid for switching from bonds to money.


Difficulty: E Type: D



9. Explain why money management is costly.

Money management is costly because there are brokerage fees and othercosts to buy and sell bonds. In addition, there are costs associated with spending time waiting in line and conducting the transactions.

Difficulty: E Type: C

10. Draw the demand curve for money balances and explain how the interest rate affects the number of switches that an individual would make between money balances and bonds.
[pic]


As interest rates fall, the opportunitycost of holding money drops as well. Therefore, we would expect to see households switching some of their assets from bonds to money.

Difficulty: E Type: D

11. Explain why the theory of money demanded presented in the book may be more complicated in real life.

The theory explained in the book assumes that a person knows the exact timing of his or her income and spending. Inreality, both of these activities may have some uncertainty attached to them. First, some people are paid in irregular intervals. Secondly, there can be some expenses that can occur unexpectedly like car repairs or medical expenses.

Difficulty: E Type: D

12. How do changes in interest rates affect the composition of bonds and money that people will want to hold?

When interest ratesare high, people want to take advantage of the high return on bonds, so they choose to hold very little money and hold more bonds.

Difficulty: E Type: D



13. Explain the speculative motive for holding money.

Investors may wish to hold bonds when interest rates are high with the hope of selling them when interest rates fall. This can be profitable since the market value of...