# T 0 t he income effect t 0 t he expectations effect t

• Homework Help
• steven.mangus
• 29
• 96% (84) 81 out of 84 people found this document helpful

This preview shows page 9 - 15 out of 29 pages.

..t 0 T he income effect ..t 0 T he expectations effect ..t I]] T he pric~teve l effect ,f 0 T he liquidity effect ElC p>tanb tl on: Open v
5. The nominal a nd rea l Interest rates Aa Aa 151 The nominal interest rate -./ Is the Interest rate determined by the forces of su pply and demand In the loanable funds market, which Is not net of expected lnn at lon. Explanation: Cl ose A T he no mina/Inte r est rate Is the interest rate determined by the f or ces of supply and demand In the loanable funds market, while the rea/Inte r est r ate Is the nominal Inter est rate adjusted for the expected lnfiatlon rate.
5. The nominal and rea l interest rates Aa Aa =t The real i nte r est r ate Is the nominal In te rest rate minus v the expe<::ted I nf l at ion rate. Explanation: Opon v
5. The nominal a nd rea l Interest rates Aa nom inal I nte r est r ate Is the real In te rest rate plus .../ the expected I nf l at ion rate. Aa a The Explanation: Open v
1. T he o pportun i ty co st of holding mon ey Aa Aa d Suppose you've just in her ited \$10,000 from a relativ e. Yo u' re t ry ing to de<: ide whether to p ut the \$10,0 00 in a n on -interest-bearing check in g acco unt so th at you can use it whenever you want (th at is, hold it as mone y) or to use it to b uy a U.S. T re asury bo nd . Suppose the interest rate on the bond is 8% pe r ye ar . Wh at would be t he opp ort unity cost of holding th e \$10 ,00 0 as mo ney? 0 \$8 per year 0 \$10 , 000 per year -./ ® \$800 per year 0 S3 20, 000 per y ear 0 S741 per year Explanation; Open v Now, suppose that the i nt erest rate fell to 4% per year. This would cause the op po rt uni ty cost of holdi ng the \$10,000 as mo ney to decrease -./ to \$400 -./ per year. Expten~tion ! What does the previous analysis suggest about the mar ket for mo ney? 0 T he qu antity of mo ney demanded decreases as the interest rat e fa ll s. V ® T he quantity of money demanded in creases as the interest rate falls. 0 T he s up ply of money is independent of t he in te rest rat e. £xplanation: Open v Ope n v
1. Th e opportunity cost of holding mon ey A• Aa ..... l Suppose you've just in her ited \$10, 00 0 From a relative. Yo u're try in g to decide wheth er to put the \$10, 00 0 in a non-interest-bearing checking a ccoun t so that you can u se it whenever you w ant (th at i s, h ol d it as money) or to use it to b uy a U.S. Tr easury bond. Suppose the Inter est rate on the bond Is 5% per year. W ha t would be the opportu nity cost of holding the \$1 0, 000 as money? 0 \$4 76 per year -1 ® \$500 per year 0 \$200,000 per year 0 \$5 per year 0 510,000 per year Expllna,lon: Clofe " If you invested \$10,000 in a government bond th at pays 5% per year, you would receive 5% of \$10,000, or \$ 500 , in interest payments. Therefore, th e oppor tunity cost of keeping your money in cash is \$5 00 per year. Now, sup pose t ha t th e interest rate rose to 11% per ye ar. Th is wo uld cause th e opportunity cost of holding the \$10, 00 0 as money to Increase -1 to \$1, tOO -1 per year.