Choose the correct answer from the brackets: A) The demand for money is mainly i
ID: 1202364 • Letter: C
Question
Choose the correct answer from the brackets:
A)The demand for money is mainly influenced by three variables: r (the short-term interest rate), Y (real GDP), and P (the aggregate Price level). Suppose r rises, but Y and P are unchanged. What happens to the quantity of money demanded?
r is both the opportunity cost of holding money and the reward for holding bonds. Thus, an increase in r causes people to want to hold (more/less ) of their wealth in the form of money and ( more/less) in the form of bonds to take advantage of the higher interest rate.
B)
Suppose real income (Y) rises while the quantity of money in the economy stays the same. What happens to money demand?
The supply of money does not automatically rise when the production of real goods and services (Y) rises. However, the collective demand for money by firms and households does rise. To get this money firms and households attempt to (buy more/ sell some of their /more /less bonds).
Thus, an increase in Y causes people to want to hold (buy more /sell some of their / more /less) of their wealth in the form of money and (buy more / sell some of their / more / less ) in the form of bonds.
C)Suppose the price level (P) rises, but Y and r are unchanged. What happens to money demand?
If Y is unchanged, people will want to buy the same amount of goods and services as before. However, since P is higher, they will need (more / less) money to do so.
Hence, an increase in P causes people to want to hold (more / less) of their wealth in the form of money and (more / less) in the form of bonds.
Explanation / Answer
Answer:
The demand for money is mainly influenced by three variables: r (the short-term interest rate), Y (real GDP), and P (the aggregate Price level). Suppose r rises, but Y and P are unchanged. So when r rises the short term interest rate is lower.
r is both the opportunity cost of holding money and the reward for holding bonds. Thus, an increase in r causes people to want to hold (less ) of their wealth in the form of money and ( more) in the form of bonds to take advantage of the higher interest rate. So that people can get more benefit from this rising interest rate. Holding money is not profitable as r has increased so opportunity cost of holding money has increased.
B)
Suppose real income (Y) rises while the quantity of money in the economy stays the same.
The supply of money does not automatically rise when the production of real goods and services (Y) rises. However, the collective demand for money by firms and households does rise. To get this money firms and households attempt to (sell more of their bonds).
Thus, an increase in Y causes people to want to hold ( more) of their wealth in the form of money and (sell more) in the form of bonds. Because holding money is more profitable than holding bonds. People need money as Y increases . Collective demand for money increases to buy more of Y as Y increases more.
C)
Suppose the price level (P) rises, but Y and r are unchanged.
If Y is unchanged, people will want to buy the same amount of goods and services as before. However, since P is higher, they will need (more) money to do so. As M/P decreases. Real value of money decreases from previous level. People need more money to satisfy the same level of utility.
Hence, an increase in P causes people to want to hold (more ) of their wealth in the form of money and (less) in the form of bonds. Because money is more liquid than bonds. As money demand increases due to the higher price level people need more wealth in form of money to purchase same amount of goods.