...CHAPTER 16 THE DEMAND FOR MONEY Chapter Outline • The Components of the Money Stock • Financial Innovation • The Functions of Money • The Demand for Money: Theory • Transactions Demand • The Precautionary Motive • The Speculative Demand for Money • Empirical Results for M2 Demand • The Income Velocity of Money • Working With Data Changes from the Previous Edition The material in this chapter has been updated, but the basic organization has not changed. Learning Objectives • Students should be able to identify the different functions of money. • Students should be familiar with the concept of money illusion. • Students should be able to identify the different monetary aggregates, especially M1 and M2, and they should know the approximate current values for M1, M2, V1, and V2. • Students should be able to identify some of the possible explanations for the increased instability of money demand the income velocity of money. • Students should be able to distinguish between the three different motives for holding money balances (transaction, precaution, and speculation). • Students should understand why the demand for money decreases with an increase in the interest rate and increases with an increase in income. • Students should know the implications of the square-root formula that is derived from the Baumol-Tobin transactions demand model. • Students should be aware that holding money has an opportunity...
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...Quantity theory of money (QTM) – suggests that the demand for real money balances is proportional to income. Quantity eqn.: MxV=PxT where M – money supply; V – velocity of money: the # of times a PhP bill changes hands for time, t; P – price level; and, T – transactions. 1 13/10/2015 Income (Y) version of the QE: MxV=PxY ◦ where V: the # of times a PhP bill enters someone’s income; ◦ P x Y: nominal GDP. This version of the QTM is used since it is difficult to observe transactions. Money Demand & the Quantity Theory of Money: uses real money balances to measure the purchasing power of the stock of money; the money demand function is like the demand function for a particular good, i.e. the convenience of holding real money balances; 2 13/10/2015 Money demand function below shows that the quantity of real money balances demanded is proportional to real income; M P D kY There is an inverse relationship between V & k: M x V = P x Y if V=1/k This implies that when: (M/P)D is high, k is large, V is small: money changes hands less; OR, (M/P)D is low, k is small, V is large: money changes hands more. 3 13/10/2015 Velocity (V) & the QTM: M x V = P x Y If V, is assumed to be constant, QTM explains what determines nominal GDP; A change in M leads to a change in nominal GDP, thus, if V is fixed, the quantity of money determines the...
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...2013 The Control of Money Supply & Demand of Money Today, we live in a world of scarcity where resources are limited and the choices one make has become so vital the economy. In the US, the government, the Federal Reserve, have control on the effect of supply and demand and money growth. As both supply and demand for money each depend on the interest rate, we specifically look at how inflation effects supply and demand on money. There are differences of money supply and demand for money; where it comes from and how it’s demanded. Given there are many variables that can effect money supply and the demand for money, we will focus on where it comes from and how inflation effects it. In the book, The General Theory of Employment, Interest, and Money by John Maynard Keynes, he explains liquidity factors in economic interest rates that balance supply and demand for money. There are two different types of interest rate that help explain, in monetary terms, how much borrowers pay for borrowed funds. Generally, during a period of inflation where prices increase, nominal interest can be misunderstood. As the nominal interest rate rises or falls, it can be misleading as to how much the borrower is truly borrowing and how much the lender is receiving. When the borrower repays the principle loan, they lender may not be able to purchase as much goods and services, then when originally loaned. This is because when the loan was initially issued the money was worth more than...
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...The first theories to hold cash is to avoid the cost of being short liquid assets (Baumol, 1952) (Tobin, 1956) (Meltzer, 1963) (Miller and Orr, 1966) and Karni (1973). Besides the fact that the cash-to-assets ratio for U.S. firms almost doubled (Bates, Kahle & Stulz, 2009) we think that U.S. firms do not hold too much cash. Firms hold cash for different motives. According to Keynes (1936) these motives are: a transaction motive, precautionary motive and speculative motive. Based upon these three motives we explain why U.S. firms hold a lot of cash. The first motive for holding cash is the precautionary motive (Keynes, 1936), which tells us that firms hold extra cash to be prepared for sudden uncertainty - a risk which cannot be hedged. Bates et al. (2009) states that an increase in idiosyncratic risk leads to an increase in cash flow volatility. This volatility increase evolves in an increase in the volatility of unhedgeable risk. A reaction to unhedgeable risk is to hold more cash. You want to have some savings when you have to do unexpected expenses. Research (Bartram, 2009) shows that U.S. firms are more exposed to idiosyncratic risk than foreign firms. This is due to several country characteristics. Because U.S. firms face larger exposures to idiosyncratic risks than foreign firms do, they will have more cash holdings. Moreover, there has been an increase in earnings volatility for U.S. firms over the past decades (Boileau and Moyen, 2012). This increase in volatility...
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...1. Introduction Money demand is an important element in macroeconomic analysis especially in constructing monetary policy. The demand of money is the quantities of money that people willing and able to hold at alternative interest rates, ceteris paribus. There are several models of money demand used to explain why individuals and businesses hold money balances like cash and checkable deposits. Those models of money demand shows how do the behavior of individuals and businesses causes the fluctuations of money balances in the economy. According to the liquidity preference theory by economist, John Maynard Keynes, he determined that there are three primary motives that people holding money.The first motive is transaction motive which explained that people holding money and used it to buying things. In this motive, money demand depends on size of income, spending habit and slightly affected by interest rate. The second motive for holding money is for precautionary motive which means that people hold money in anticipation of wishing to make huge transactions in the future. People will keep money on hand just in case to overcome unforeseen emergency. The demand of money in order for precautionary motive is depend on size of income, nature of person and farsightedness. The last is speculative motive which people will like to keep money in the liquid form and invested in securities when the interest rate are rises thus it can be said that hold wealth as money to store value. This motive...
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...COURSE UNIT: EC223 MONEY AND BANKING DATE OF SUBMISSION: NAME: KALULE RICHARD REG NO: 10/U/66/BEK/GV SIGNATURE Money can be defined as any thing that is generally acceptable as a medium of exchange. It can also be defined as a third commodity that is introduced between two other commodities to facilitate exchange. Money can therefore be looked at as an instrument that helps in fulfillment of contracts, discharge of debts and as a standard of deferred payment. Due to the obligation of people to accept money in the discharge of debts, money is often referred to as legal tender. The demand for money can be defined as the desire by the public to hold cash other than investing it in interest earning assets. it can also de defined as the desire by the individuals and businesses to hold their incomes partly in cash and partly in form of assets. The question of why do people demand for money has been a great topic of discussion among the economists from the days of the classical economists to the monetarists but like many other economic phenomena, no common consensus has ever been reached. Unlike the goods and services, money has no intrinsic value that is to say does not provide direct utility. Instead, the existence of money helps in improving the transactions where we obtain goods that satisfy human wants. Money is therefore useful because it provides an improved alternative in transactions technology over barter trade. The demand for money arises from the two...
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...given time, this is so as to avoid banking instability as attested to during the banking crisis of 2008. Commercial banks keep a tiny portion of their demand deposits as reserves, and this is informed by the assertion that depositors seldom withdraw all their demand deposits at a given time, unless there is a bank run of course. This system of fractional reserve aid banks in the creation of demand deposits, and this demand deposits are above what the bank has as reserves. How cash has evolved from commodity money to the current fiat money system. Under the commodity money system standard money had abstract value. The measurement of money was defined as the aggregate quantity of precious metals coins of a specific quality i.e. weight and design ,circulating within the borders of a country. Sources of money creation. 1).Minting of new coins can be facilitated by: -Recently extracted gold. -Melting existing from jewellery or ornaments. 2).The balance of payment surplus resulting from foreigners demand for local goods bring s in foreign gold. Countries are relatively not equally endowed in gold deposits, and thus countries with no gold deposits would rely on the melting of jewellery brought to the smelters by the rich of the country this proved inefficient during economic growth era. Countries had to stimulate demand of their exports and thus a surplus balance of payments account. This brought much needed gold coins or bullion in to the country. The very same way that...
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...Securities Liquid Money – Cash Page 230 230 231 231 B. Liquidity Preference and the Demand for Money 232 C. Implications of the Interest Sensitivity of the Demand for Money Interest Rates and Demand for Goods and Services Classical and Monetarist View The Keynesian View of Interest Rates and Expenditure Implications of the Differences 234 234 235 235 235 D. Changes in Liquidity Preference 237 E. The Quantity Theory of Money and the Importance of Money Supply The Money Equation Diagrammatic Representation of the Quantity Theory of Money 238 238 238 F. Methods of Controlling the Supply of Money Interest Rate Control Control over Banking Ratios Direct Controls over Banks Control of Government Borrowing 240 240 240 240 241 G. Monetary Policy and the Control of Inflation 241 © ABE and RRC 230 Monetary Policy Objectives The aim of this unit, in conjunction with Study Unit 12, is to explain and evaluate the effectiveness of monetary policy in a closed and open economy and discuss the possible impact of monetary policy on business decision-making. When you have completed this study unit and Study Unit 12 you will be able to: demonstrate an understanding of the relationship between the banking system and the creation of money identify the components of the high-powered money stock and explain why these have a magnified impact on the money supply explain the quantity theory of money and its role in explaining...
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...would remove coins from circulation and sell them for their metallic content. M2 = M1 + noncheckable savings deposits + money market deposit accounts + small time deposits + money market mutual fund balances. M3 = M2 + large time deposits (those of $100,000 or more). Near-monies are components of M2 and M3 not included in M1. M3 is distinguished from M2 by large time deposits (certificates of deposits). 5.) There is no concrete backing to the money supply in the United States. Paper money, which has no intrinsic value, has value only because people are willing to accept it in exchange for goods and services, including their labor services as employees. And people are willing to accept paper as money because they know that everyone else is also willing to do so. If the monetary authorities were issuing new banknotes at a rate far in excess of available output, the acceptability of paper money would diminish. People would start to worry about whether the banknotes would be worth much after they received them. Checks are part of the money supply and are not legal tender, but people accept them willingly from people believed trustworthy. The value or purchasing power of money is inversely related to the price level. The Board of Governors of the Federal Reserve System (the Fed) is responsible for managing the United States’ money supply so that money retains its value. 6.) In the first case, the value of the dollar (in year 2, relative to year 1) is $.80 (= 1/1.25);...
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...CHAPTER 11 MONEY, INTEREST, AND INCOME Chapter Outline • The Goods Market and the IS Curve • Investment and the Interest Rate • The Slope of the IS Curve • The Role of the Multiplier • The Position of the IS Curve • A Summary of the IS Curve • The Money Market and the LM Curve • The Demand for Money • The Supply of Money, Money Market Equilibrium and the LM Curve • The Slope of the LM Curve • Shifts in the LM Curve • A Summary of the LM Curve • Equilibrium in the Goods and Money Markets • Changes in the Equilibrium Income and Interest Rate: A First Look at Policy • Deriving the Aggregate Demand Curve • Working With Data Changes from the Previous Edition One of the major problems with this chapter in the previous editions is that the material was presented in a manner that made it sound like it would be difficult, which is not true. Therefore, the long introduction has been shortened, the confusing diagram (former Figure 12-2) has been removed, and the extra part concerning outline of the chapter has been removed. The derivation of the IS curve section has been rewritten at the beginning. Box 11-1 and Box 11-2 and 11-3 are new The LM curve section has been rewritten to make it more clear, and the relevant diagrams are now side by side, which makes much more sense. The last section of the chapter is rewritten to show the comparative statics of shifts in IS and LM; this serves as a good introduction to Chapter 12. Learning...
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...Macroeconomics, 9e - TB1 (Case/Fair/Oster) Chapter 12 Aggregate Demand in the Goods and Money Markets 12.1 Planned Investment and the Interest Rate 1 Multiple Choice 1) The market in which the equilibrium level of aggregate output is determined is the A) labor market. B) bond market. C) money market. D) goods market. Answer: D Diff: 1 Topic: Planned Investment and the Interest Rate Skill: Conceptual 2) The market in which the equilibrium level of the interest rate is determined is the A) money market. B) goods market. C) labor market. D) services market. Answer: A Diff: 1 Topic: Planned Investment and the Interest Rate Skill: Conceptual 3) The two links between the goods market and the money market are A) income and the inflation rate. B) the interest rate and the unemployment rate. C) income and the interest rate. D) the inflation rate and the unemployment rate. Answer: C Diff: 2 Topic: Planned Investment and the Interest Rate Skill: Conceptual AACSB: Reflective Thinking 4) Which of the following is determined in the goods market? A) the equilibrium interest rate B) money demand C) income D) money supply Answer: C Diff: 1 Topic: Planned...
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...Money and price level *Recall that regarding the money supply, the Central Bank has tools that enables it to control money supply ( the capability of Commercial Banks to create deposits), most important tools: Open market operations by CB selling or buying governmental bonds, changing the discount rate which is the interest rate on loans from CB to commercial banks & changing the legal reserve ratio. So if the CB seeks to adopt a loose monetary policy it can decrease the discount rate, decrease the legal reserve ratio,& go through an open market operation by buying gov. bonds.( & vice versa if CB seeks to adopt a tight monetary policy). *In addition to the public`s demand for money for TRANSACTIONS that is affected by the general price level & real GDP..., do speculators demand money? Yes, as they try to achieve profits from the fluctuations in the market price of bonds, ie they buy bonds, when their market price is low & sell bonds ,when their market price is high, thus achieving profits. However, what determines the market price of bonds? the following example helps you to understand: If a bond promises to pay $100 ONE YEAR from NOW, & the interest rate was5%, WHAT IS THE MAXIMUM AMOUNT OF MONEY YOU ARE READY TO PAY NOW for that bond?ie what is its market price? We have to calculate the PRESENT VALUE of the $100 by using the following equation: Present value = Return / 1+5% 95.24 = 100 / 1.05 What do you notice? We notice...
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...Jahangirnagar University Institute of Business Administration Essay On The Standard Supply & Demand Model and The Aggregate Supply & Demand Model Course: BUS 209-Macroeconomics Submitted to: Dr. Shuddhasattwa Rafiq Director and Associate Professor Institute of Business Administration Jahangirnagar University Submitted by: Md. Nahid Alam Class ID: 2368 (21st batch) Institute of Business Administration Jahangirnagar University Date of Submission: 11-06-2013 Essay On The Standard Supply & Demand Model and The Aggregate Supply & Demand Model June 11, 2013 Dr. Shuddhasattwa Rafiq Director and Associate Professor Institute of Business Administration Jahangirnagar University Savar, Dhaka-1342. Subject: Essay Submission. Sir It’s my immense pleasure to submit the essay on “The Standard Supply & Demand Model and The Aggregate Supply & Demand Model” that you have assigned me at the beginning of this semester. Submitting this essay is the partial fulfillment of this particular course. I believe that this essay will help to understand supply and demand, how supply and demand curves derive in microeconomics & macroeconomics and what determines the slopes of supply and demand curves. Thank you for giving the opportunity to prepare this report. It was really a wonderful experience. I hope you find this essay satisfactory. Sincerely, ------------------------- TABLE OF CONTENTS Context Name | Page...
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...PRE-TEST – ANSWER KEY Econ 361, 1st Hourly Prof. Khan Mohabbat 1. The broadest measure of the aggregate price level is the a) GDP deflator.* b) consumer price index. c) producer price index. d) d. gross domestic product. 2. If the value of a price index was 125 for 2005 and 75 for 1982, and GDP was 2500 in 2005 compared to 600 in 1982, the value of real 2005 GDP in terms of 1982 prices is a) 1500.* b) 1000. c) 2500. d) 360. 3. The index that measures the change in price of a typical basket of consumer goods is a) the GDP deflator. b) the consumer price index.* c) nominal GDP. d) real GDP. 4. Personal income equals personal disposable income plus a) payroll taxes. b) transfer payments. c) dividend payments. d) personal saving. e) personal taxes.* 5. If real GDP exceeds potential GDP, this means that a) output is below the level produced at the benchmark rate for high employment and high rate of resource utilization. b) this cannot occur; the economy can never be at a point where real GDP exceeds potential GDP. c) cyclical output is above what the economy can sustain in the long-run.* d) the economy is expanding. 6. In the base year, the relationship between nominal and real GDP is a) uncertain. b) one of equality.* c) real GDP is higher. d) nominal GDP is higher. 1 7. Gross domestic product includes a) all intermediate and final goods and services produced. b) the current production of final goods and services with a country’s borders.* c) exchanges of assets. d) the...
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...these schools differ in their belief of what policies are best suited to attain full employment in the economy. Keynesians tend to favour demand side policies and are more prone to intervene in the market and therefore prefer to use fiscal policy whilst monetarists believe adjustments in money supply is more appropriate in stabilising the market ,therefore preferring monetary policy. In this essay I will discuss the views of Keynesians and monetarists regarding the effectiveness of monetary and fiscal policies in controlling aggregate demand through the IS-LM framework. I will first provide a brief description of the curves explaining their formation and what they represent and then I will go on to examine monetary and fiscal policy within the IS-LM framework. Finally, I will examine the views of monetarist and Keynesians regarding the effectiveness of both policies in raising the level of national l income and also consider the extreme cases. IS-LM framework The IS-LM model was initially developed by John Hicks in 1937 but was made popular in 1949 by Hansen in order ‘to provide a framework for analyzing the factors determining the level of aggregate demand’. The IS-LM model is a short run model of the determination of output. It shows the unique combination of income and interest rates that lead to an equilibrium in both the goods and money market at the same time (Begg, 2008). The IS-LM model is presented on the diagram below. The IS (Investment and saving) curve represents...
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