ECON-1007EL Chapter Notes - Chapter 28: Aggregate Demand, Longrun, Human Capital

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rubygoose773

22 May 2018

School

Laurentian

Department

Economics / Science Èconomique

Course

ECON-1007EL

Professor

B. Eastman

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Chapter 28: Money, Interest Rates, and Economic Activity

Definitions

Present Value (PV)

(Discounted Present Value)

The value now of one or more payments or receipts made in the future

Demand for Money

The total amount of money balances that the public wants to hold for all

purposes

Monetary Equilibrium

The situation in which the quantity of money demanded equals the

quantity of money supplied

Monetary Transmission

Mechanism

The channels by which a charge in the demand for or supply of money

leads to a shift of the aggregate demand curve

Long-Run Money

Neutrality

The idea that a change in the supply of money has no long-run effect on

any real variables; it affects only the price level

Equations

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  



  



  



  



  

Key Points

• The present value of any bond that promises a future payment or sequence of future

payments is negatively related to the market interest rate.

• The present value of a bond is the most someone would be willing to pay now to own the

bond’s future stream of payments.

• The equilibrium market price of any bond is the present value of the income stream that it

produces.

• An increase in the market interest rate leads to a fall in price of any given bond. A

decrease in the market interest rate leads to an increase in the price of any given bond. A

reduction in the market interest rate will reduce bond prices and increase bond yields.

Therefore, market interest rates and bond yields tend to move together.

• An increase in the riskiness of any bond leads to a decline in its expected present value

and thus to a decline in the bond’s price. The lower bond price implies a higher bond

yield.

• Other things being equal, the demand for money is assumed to be negatively related to

the interest rate.

• Other things being equal, the demand for money is assumed to be positively related to

real GDP.

• Other things being equal, the demand for money is assumed to be positively related to

price level.

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Related Questions

Suppose the money supply (as measured by deposits) is currently $250 billion. The reserve requirement is 20%. Bank holds $50 billion in reserves, so there are no excess reserves.

The federal reserve ("the fed") wants to increase the money supply by $25 billion, to $275 billion. It could do this through open market operations or by changing the reserve requirement. Assume for this question that you can use the deposit expansion multiplier.

1. If the fed wants to increase the money supply using open market operations it should ___(buy/sell) _____worth of U.S. government bonds.

2. Banks, as financial intermediaries, create value for depositors such as Yvette by doing which of the following? (Check all that apply)

A. Create networks

B. Keep credit rates low pay interest

Match the correct motive for holding money to the following definitions:

A. Transactions demand for money

B. Precautionary demand for money

C. Speculative demand for money

3. The stock of money people hold to pay unpredictable expenses

4. The stock of money people hold to pay everyday predictable expenses

5. The stock of money people hold to take advantage of future changes in the price of non-money financial assets

Identify the motive for holding money in the following scenario.

6. Brain recently moved from a commission-based sales job.

greenmoose823

Question 1. (0.1 pt) According to the wealth effect, a higher price level will (decrease, increase)

the number of goods and services demanded. (Circle the correct answer for each.)

Question 2. (0.2 pt) If the central bank wants to expand aggregate demand, it can (decrease, increase)

the money supply, which would (decrease, increase) the interest rate.

(Circle the correct answer for each.)

Question 3. (0.2 pt) Monetary policy that contracts the money supply, will (decrease, increase) the

interest rate causing the aggregate demand curve to shift (in, out).

(Circle the correct answer for each.)

Question 4. (0.7 pt) The Federal Reserve contracts the money supply by 5 percent.

(Make sure to label your axes.)

a. ) Use the supply of money and the demand for money diagram to illustrate the impact of this policy on the interest rate.

b. ) Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run.

Question 5 . (0.8 pt) Explain how each of the following developments would affect the supply of money,

the demand for money, and the interest rate. Illustrate your answers with diagrams.

(Make sure to label your axes.)

a. ) The Fed's bond traders sell bonds in open-market operations.

b. ) An increase in credit-card availability reduces the cash people hold.

c. ) The Federal Reserve reduces banks' reserve requirements.

d. ) Households decide to hold more money to use for holiday shopping.

apricotantelope345

1. According to the principle of monetary neutrality:

a. Changes in the money supply do not affect real variables.

b. Real variables do not affect nominal variables.

c. Nominal variables are not adjusted for inflation and real units are adjusted for inflation.

d. Nominal variables are expressed in monetary units and real variables are expressed in physical units.

2. The velocity of money is:

a. The speed at which the money multiplier works.

b. The speed at which prices rise in the economy.

c. The time it takes for checks to be cleared by the Fed.

d. The rate at which money changes hands.

3. If the Fed increased the supply of money, and velocity remains unchanged, according to the quantity equation:

a. P x Y must decrease.

b. Y must decrease.

c. P x Y must increase.

d. Y must increase.

4. When inflation turns out to be higher than expected, borrowers will be ________ off, and lenders will be ________ off.

a. Better, better

b. Better, worse

c. Worse, worse

d. Worse, better

5. Suppose the value of goods and services produced in an economy is $10 billion, but the total money supply is $1 billion, what is the velocity of money?

a. 0

b. 1

c.5

d. 10

6. The quantity theory of money states that:

a. All else equal an increase in money growth will lead to a proportionate increase in prices in the long-run.

b. All else equal an increase in money growth will lead to a proportionate increase in prices in the short-run.

c. An increase in money growth can lead to inflation if and only if velocity is constant.

d. An increase in money growth must lead to a decrease in velocity.

7. In a country with hyperinflation, the value of money

a. Is increasing over time.

b. Is decreasing quickly over time.

c. Is remaining constant.

d. May either be increasing or decreasing.

ECON-1007EL Chapter Notes - Chapter 28: Aggregate Demand, Longrun, Human Capital

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