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Chapter 11_Money Interest Real GDP Price

Chapter 11_Money Interest Real GDP Price - MONEY INTEREST...

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MONEY, INTEREST, REAL GDP, AND THE PRICE LEVEL 11 CHAPTER
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Objectives After studying this chapter, you will able to Explain what determines the demand for money Explain how the Fed influences interest rates Explain how the Fed’s actions influence spending plans, real GDP, and the price level in the short run Explain how the Fed’s actions influence real GDP and the price level in the long run and explain the quantity theory of money
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Ripple Effects of Money There is enough money in the United States today for everyone to have a wallet stuffed with $2,300 in notes and coins and another $19,000 in the bank. Why do we hold so much money? Through 2001, as the economy slowed, the Fed cut interest rates 11 times. In 2002 and 2003, the Fed cut the interest rate even further to historically low levels. How does the Fed change the interest rate and with what effects?
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The Demand for Money The Influences on Money Holding The quantity of money that people plan to hold depends on four main factors The price level The interest rate Real GDP Financial innovation
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The Demand for Money The price level A rise in the price level increases the nominal quantity of money but doesn’t change the real quantity of money that people plan to hold. Nominal money is the amount of money measured in dollars. The quantity of nominal money demanded is proportional to the price level — a 10 percent rise in the price level increases the quantity of nominal money demanded by 10 percent.
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The Demand for Money The interest rate The interest rate is the opportunity cost of holding wealth in the form of money rather than an interest- bearing asset. A rise in the interest rate decreases the quantity of money that people plan to hold. Real GDP An increase in real GDP increases the volume of expenditure, which increases the quantity of real money that people plan to hold.
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The Demand for Money Financial innovation Financial innovation that lowers the cost of switching between money and interest-bearing assets decreases the quantity of money that people plan to hold.
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The Demand for Money The Demand for Money Curve The demand for money curve is the relationship between the quantity of real money demanded ( M / P ) and the interest rate when all other influences on the amount of money that people wish to hold remain the same.
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The Demand for Money Figure 27.1 illustrates the demand for money curve. The demand for money curve slopes downward A fall in the interest rate lowers the opportunity cost of holding money and brings an increase in the quantity of money demanded--a movement downward along the demand for money curve.
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The Demand for Money A rise in the interest rate increases the opportunity cost of holding money and brings an decrease in the quantity of money demanded--a movement upward along the demand for money curve.
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The Demand for Money Shifts in the Demand for Money Curve The demand for money changes and the demand for money curve shifts if real GDP changes or if financial innovation occurs.
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