AP EXAM: Unit 4 Flashcards
What’s the most liquid form of money?
Cash
What are bonds?
Interest-bearing debt contracts issued by governments or corporations
Why is interest rate important in bonds?
No rational investor would be willing to pay without getting a sufficient rate of return, because there’s no benefit.
Interest on Investment (Formula)
Investor’s return/Purchase price x 100
Role of interest rate in investment and demand for money
Demand for money is inversely related to interest rate in the economy
How is nominal interest rate set?
Based on desired rate of return and expected rate of inflation
Role of expected inflation in the economy
Higher expected inflation will lead banks to raise the inflation premium and increase NIR
Commodity money
Value comes from the commodity of which it is made
Fiat money
No intrinsic value
Three functions of money
Medium of exchange, store of value, unit of account
Medium of exchange
Money is accepted as a means for purchasing goods, services, or other assets
Store of value
Assets can transfer purchasing power from present to future
Unit of account
Used to express the value of something
M0
Monetary base (currency in circulation, reserves held at bank)
M1
Monetary base + Demand Deposits
M2
M1 + Savings, MM Mutual Funds, broadest measure of money supply
Reserve requirement ratio
Required reserves/Total deposits
Money multiplier
1/RRR
Relationship of money multipler and money supply/monetary base
Money multiplier is ratio of money supply to monetary base
Other ways multiplier can be calculated
M2/M0 (Ratio of M2 over M0)
Asset demand for money
Inversely related to the interest rate
Transaction demand for money
Inversely related to the interest rate
What causes changes in the money demand curve?
Change in national income and consumption
Factors that shift the supply of money
Monetary policy
Relation between interest rates and demand for money
Inflation –> Money Demand increases, Deflation –> Money demand decreases
Tools for controlling supply of money used by central bank
Buying/selling of government bonds, changing reserve requirement ratio, changing discount rate
Formula for desired change in money supply
Change in excess reserves multiplied by the money multiplier
Needed sale of bonds formula
Desired change in money supply over money multiplier
Demand in the loanable funds market illustrates…
The relationship between the RIR and the willingness to save funds, and the willingness to borrow funds for investment
Formula for investment in a closed economy
I = Y (real output) - C (consumption) - G (government purchases)
In a closed economy, national savings…
Is the sum of both private sector and public sector savings
The supply of loanable funds describes the relationship between…
The real interest rate and the quantity of funds supplied by a nation’s households and firms
Formula for investment in an open economy
I = National savings (S) + Net capital inflow
