HW 10 Solution - Econ 201 HW 10 36 1 Why is there a...

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Econ 201 HW 10 36 1. Why is there a trade-off between liquidity and the return on money? (1) People prefer liquid assets, as it is always nice to have the option to buy things. People need to be compensated for giving up that freedom. So, in order to convince people to keep their money in some illiquid form, they need to earn a return. Furthermore, the less liquid the asset, the greater return people need to earn. 2. Why do households prefer to hold assets in liquid form, ceteris paribus? (2) Because the greatest way to get value from their assets is to be able to exchange them for goods and services that we want. So, we want liquid assets so that we can, in fact, buy things. 3. Characterize each of the following as M1, M2, or neither: (6) a. $50 bill M1 (technically, both M1 and M2) b. Money in a savings account M2 c. Money in a certificate of deposit (CD) M2 d. A 2-year government bond Neither. The bond is insufficiently liquid to be in either group. e. Money in a checking account M1 (technically, both M1 and M2) f. Credit card Neither. A credit card is more accurately described as a loan rather than as actual money. 4. A. If the U. S. used commodity money (gold, for example), what happens to the price level if the economy grows but the money supply does not? Explain your answer.
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