Textbook Notes (368,789)
Canada (162,165)
Economics (326)
ECON 110 (199)
Chapter 28

Chapter 28.docx

4 Pages
98 Views
Unlock Document

Department
Economics
Course
ECON 110
Professor
Ian James Cromb
Semester
Winter

Description
Chapter 28: Money, Interest Rates, and Economic Activity Understanding Bonds Present Value and the Interest Rate  Present value (PV) is the value now of one or more payments to be made in the future o Depends on the current interest rate to determine the present value A Single Payment One Year Hence  R is the amount we receive one year from now, i is the annual interest rate 1 o Present Value = R 1 (1+i) A Sequence of Payments  Present Value =  R 1 first payment, R 2 Second payment, R = Tinal payment + FV of bond  i = is the annual interest rate  The exponent is the period (1=payment in first period, 2 = second, etc.) Present Value and the Market Price  The PV of a bond is the most someone is willing to pay now to own the bond’s future stream of payments  equilibrium market price is PV of the income stream it produces o Wouldn’t pay more than the PV because you could just put the money in another area and get the same return without paying more Interest Rates, Market Prices, and Bond Yields  An increase in the market interest rate leads to a fall in the price of any given bond  A decrease in the market interest rate leads in an increase in the price of any given bond  Remember: The cost of the investment is the price of the bond, the return on the investment is the sequence of future payments o If your ROI on the bond is 8%, your yield on the bond is 8% per year  As the price of the bond drops due to increasing market rates, your yield increases o Investment costs less but you have the same rate of return Bond Riskiness  An increase in the riskiness of any bond leads to a decline in its expected present value o Leads to a decline in the bond’s price implying a higher bond yield The Demand for Money  This is the total amount of money that the public wants to hold for all purposes  Assumption: Only two types of assets (money and bonds) – if households and firms are dividing their given stock and you know the demand for one, you also know the other Three Reasons for Holding Money 1. Transactions demand for money – households and firms hold money in order to carry out transactions  want it to be readily available 2. Precautionary demand for money – Firms and households are uncertain about when some expenditures will be necessary and they hold money as a precaution to avoid the problems associated with missing a transaction 3. Speculative demand for money – Involves firms speculating about how interest rates are likely to change in the future  don’t want to lose money from bond’s value dropping The Determinants of Money Demand The Interest Rate  The cost of holding income is the money that could have been earned if it were instead in the form of interest-earning bonds o An increase in the interest rate leads firms and households to reduce their desired money holdings  reduction in interest rates leads to increased money holdings Real GDP  The amount of transactions that firms and households make is positively related to the level of income and production in the economy – i.e. The level of real GDP  An increase in the real GDP increases the volume of transactions in the economy and is assumed to cause an increase in desired money holdings The Price Level  An increase in the price level leads to an increase in the dollar value of transactions even if there is no change in the real value of transactions o As P rises, households and firms will need to hold more money in order to carry out the same real value of transactions  increase in desired money holdings Monetary Equilibrium and National Income Monetary Equilibrium  Side Note: If MS curve is vertical, it is assumed to be independent of the interest rate o MS shifts to the right if the BoC increases reserves or if commercial banks decide to lend out a larger fraction of their reserves  opposite = shift left  MD curve is downward sloping indicating that households/firms decide to hold more money and fewer bonds when the interest rate falls  Monetary Equilibrium occurs when the demand for money = the supply of money  If there is excess supply of money, the interest rate falls bringing it to equilibrium  If there is excess demand for money, the interest rate rises bringing it to equilibrium The Monetary Transmission Mechanism  This is the channels by which a change in the demand for or supply of money leads to a shift of the AD curve  three stag
More Less

Related notes for ECON 110

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit