Economics 102
UCLA
E. McDevitt
SQ#4: Money and the Money Market
1. Define each term in the equation of exchange.
2. What is the quantity theory and what are its implications? A variation of the
quantity theory treats the
growth rate of income velocity and the growth rate of real GDP as constants (in the long run).
What does this
imply about the relationship between the growth rate of the money supply and the growth rate of the price
level (inflation rate)?
3. Derive the Cambridge equation from the equation of exchange. How do we interpret (1/V) in the
Cambridge equation? True or false: An increase in the expected inflation rate results in an increase in V.
4. What is meant by the "demand for money"? What benefits do you derive form holding money? What are
the costs of holding money?
5. Explain how each of the following affects the demand for money:
a. a decrease in the expected real rate of interest.
b. a rapid increase in the money supply which leads the public to expect higher inflation rates.
c. an increase in real income.
For each of the above, how would we show the impact on desired money holdings in the Cambridge equation?
...in the equation of exchange?
6.
For
the US, a comparison of between M and P over several decades showed a relatively tight
correspondence between M and P until around 198384. After this period, they tended to diverge for some
years. Use the following information to offer a possible reason for this observation. Use the equation of
exchange to frame your arguments.
a. From 1978 to 1981, annual inflation rates ranged from 7.9% to 10% (quite high by historical standards). In
1982, the inflation rate dipped to 6.1% and in 1983 it fell 4.1%. (Hint: What do you think happened to the
public's inflationary expectations over this period?)
b. The early 1980s witnessed significant banking deregulation that lead to, among other things, interestpaying
checking accounts. (Hint: If interest is paid on money, then the opportunity cost of holding money is rr
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 Spring '09
 EDWARDMCDEVITT
 Economics, Inflation

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