Ch 3 - The demand for money

Question 1

Why do we need money?

Answer 1

To solve the double coincidence o f wants problem associated with barter and to avoid the lack of trust between the payer and the payee in a transaction

Question 2

Name 4 determinants for money demand at the individual level

Answer 2

interest differentials, cost of transfers, price uncertainty of assets and the expected pattern of expenditure and receipts

Question 3

What are the 3 motives for money demand as per Keynes?

Answer 3

Transaction, precautionary and speculative motives

Question 4

State 2 shortcomings of Keynes’ liquidity preference model

Answer 4

Interest rates are sticky, differences of opinion on the interest rate

Question 5

Avg money demand is a positive function of _________ and ______. It is also a negative function of _________

Answer 5

Transaction costs, income/exp, int rate earned on alternative assets

Question 6

State 2 disadvantages of the Baumol- Tobin model

Answer 6

Assumes that the pattern of expenditure and receipts is known, does not correspond with empirical evidence

Question 7

Describe Keynes’ liquidity preference model

Answer 7

This model assumes that individuals hold their expectations of interest rate movements with certainty and thus, people will hold either as little cash as possible or everything as cash

Question 8

What is the Tobin portfolio selection model?

Answer 8

To overcome the problem presented in the Keynes’ liquidity preference model, Tobin considered the problem of how much money to hold as one where individuals maximize utility by choosing between assets in a portfolio

Question 9

The vertical LM curve represents the _____

Answer 9

Classical case

Question 10

The horizontal LM represents the _______

Answer 10

Liquidity trap

Question 11

Why do money demand functions break down?

Answer 11

Greater financial innovation, oil shocks, misspecified model, structural breakdown, overly simplified economics, financial system is subject to rapid change

Question 12

Typically, the transactions and precautionary motives are _______ volatile than the speculative motive

Answer 12

Less

Question 13

`In the Keynes liquidity preference model, individual’s demand for money as a function of int rate is a _______ function

Answer 13

Step

Question 14

In the Keynes liquidity preference model, if the actual int rate is _____ than the expected int rate, individuals put all their financial wealth in the form of money to avoid capital losses associated with holding bonds

Answer 14

Less

Question 15

In the Keynes liquidity preference model, if the actual int rate is _____ than the expected int rate, expected int rate would be associated with a capital gain from holding bonds, Thus the individual would hold as little money as possible

Answer 15

Greater

Question 16

What is the plunger problem?

Answer 16

As individuals hold expectations of int rate with certainty, they either hold no money and all long term bonds, or held all money and no bonds. Individuals were plungers-all or nothing

Question 17

The Baumol Tobin model, models the _______ demand for money

Answer 17

Transactions

Question 18

What is the objective in the Baumol Tobin model?

Answer 18

Choose the optimal amount of money to withdraw on each bank visit in order to minimize the cost of holding money

Question 19

As per the Baumol Tobin model, interest and income elasticities are ______ and ___________ respectively

Answer 19

-1/2 , 1/2

Question 20

Why do bonds carry a positive risk/ variance?

Answer 20

Due the possibility of capital gains or losses if the bond is sold before maturity

Question 21

In the Tobin portfolio selection model, the individual’s objective is to _______

Answer 21

Determine the optimal weight to be placed in money and bonds

Question 22

What do you mean by ‘money is homogenous of degree 1’?

Answer 22

If the price level doubles, the demand for nominal money balances doubles