Chapter+9+-+Demand+for+Money

Chapter+9+-+Demand+for+Money - Study Guide To Accompany...

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Chapter 9 Study Guide To Accompany Macroeconomics: Theory and Policy By B. Modjtahedit Prepared by T. J. McCarthy and B. Modjtahedi University of California, Davis
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Key Points Liquidity preference theory: explains interest rates in terms of the supply of money and demand for money. The supply of money and demand for money are stock variables: They are measured at a point in time. Supply of money: the total amount of money that people actually hold at a point in time Demand for money: the total amount of money that people are willing and able to hold at a point in time (desired holdings of money) For people to be able to hold a certain amount of money, this amount must be no more than the total value of their assets, so demand for money can also be defined as the portion of their total wealth that people want to hold as money. For simplicity, money and bonds are assumed to be the only kinds of assets.
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Key Points Generally, for stock variables such as assets, demand and supply mean desired and actual holdings. Demand for bonds: the total amount of bonds that people are willing and able to hold at a point in time Supply of bonds: the total amount of bonds that people actually hold at a point in time Refresh your memory: an asset is anything that has value because it is expected to bring the owner some benefits in the future The value of all the assets owned by an individual is that individual’s total wealth
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Key Points Classical economists believed that money is only used as a medium of exchange and, therefore, demand for money is a constant fraction of nominal GDP M d = k × P × Y Money market will be in equilibrium if the supply of money (M) equals the demand for money (M d )—if people hold the amount of money they want to hold. M = M d So money market equilibrium implies: M = k × P × Y The parameter k is called the Cambridge k and is assumed constant in the classical model.
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Key Points Implications: Given Y, an increase in M will cause an increase in P. Given M, an increase in Y will cause a decrease in P. The rate of growth of nominal GDP (P × Y) equals the rate of growth of money supply (M)
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Key Points The Cambridge k is related to velocity of circulation of money (V), which is the number of times a dollar changes hands. Cambridge k is the inverse of the velocity Classical economists such as Irving Fisher assumed that V was constant because they thought it depended on the technological, cultural, and institutional factors. But where is k coming from and why it is assumed constant? ° = ± × ² ³ ³ × ° = ± × ² ³ = 1 ° × ± × ² = ´ × ± × ²
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Key Points Keynes said, classical economists had ignored the role of interest rate on demand for money. Two opposing forces affect demand for money: 1. Interest income and capital gains from bonds r M d r M d 2. Convenience of Liquidity P or Y M d proportionately P or Y M d proportionately
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Key Points r M M d r M M d A decrease in r An increase in r If the rate of interest
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Chapter+9+-+Demand+for+Money - Study Guide To Accompany...

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