5 - Money and GDP Equilibrium

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Gustavo Indart

MONEY AND GDP EQUILIBRIUM Assets Market: 1. Money does not pay any return 2. Bonds pay a return. The yield of the bond is the rate of interest (i) in the economy Present value (PV): value now of one or more payments or receipts made in the future; often referred to as discounted present value The opportunity cost of holding money is the interest forgone (i) by not holding bonds instead The Demand for Money Transaction motive: - To make regular payments - Money as a medium of exchange Precautionary motive: - To make unexpected payments - Money as a medium of exchange Speculative motive: - Expectations about returns on other assets (bonds) - Money as a store of value The Determinants of Money Demand M D M (iD Y, P) Interest rate (i): demand for money is negatively related to i Real GDP (Y): demand for money is positively related to the level of Y Price level (P): demand for money is positively related to P. We’ll assume however, P is fixed The Liquidity Preference Curve The curve depicting the demand for money as a function of the rate of interest is called the liquidity preference curve. Assuming Y and P are constant, the demand for money is
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