solutions2 - 7 i Note that “ real GDP=nominal GDP/price...

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1. ii) Bank reserves are liability of central bank. 2. i) New financial instruments are not as liquid as M1, but still act like money. Broader aggregates enable us to consider instruments which are not M1. 3. iii) It has no intrinsic value. It acts as money sorely because people in the economy agreed to accept it as money. 4. ii) There is an inverse relationship between interest and price of bond. 5. ii) If the interest is very high, economic agents have no reason to keep more money in wallet than is needed. If they do they are losing interest. Thus they will go to bank and withdraw whenever they need. With low interest, the story will be the opposite. 6. iii) The entrepreneur will determine the amount of investment such that pMPK=user cost.
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Unformatted text preview: 7. i) Note that “ real GDP=nominal GDP/price level ” 8. ii) If an economic agent holds more cash and less deposit, then the bank will have less cash with which they can create money. 9. i) 10. i) Friedman thought that money demand is affected by interest rate. However, not as much as Keynes thought since money is special. 11. ii) With higher interest rate, banks will try to make more loans and reduce reserves. Otherwise they are losing the interest revenue which they could have gained. 12. iii) Whether a financial instrument belongs to M1, M2 or M3 depends on its degree of liquidity. The more liquid the smaller number it bears. Since bonds are not cash, it will belong to either M2 or M3. If it matures early, then it is M2....
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