Chapter 5

Question 1

how does wealth affect assets?

Answer 1

Holding everything else constant, an increase in wealth raises the quantity demanded of an asset

Question 2

How does risk affect an asset?

Answer 2

Holding everything else constant, if an asset’s risk rise relative to that of alternative assets, its quantity demanded will fall

Question 3

How does liquidity affect an asset?

Answer 3

The more liquid an asset is relative to alternative assets, holding everything else unchanged, the more desirable it is and greater the quantity demanded will be

Question 4

What does wealth, expected rate of return, risk and liquidity in regard to assets assemble?

Answer 4

The theory of portfolio choice

Question 5

What is market equilibrium?

Answer 5

When the amount that people are willing to buy (demand) = the amount people are willing to sell at a given price (supply)

Question 6

What does excess supply mean?

Answer 6

quantity of ‘bonds’ supplied exceeds quantity of ‘bonds’ demanded

Question 7

What does excess demand mean?

Answer 7

the quantity demanded is greater than the quantity supplied

Question 8

What is the asset market approach?

Answer 8

emphasises stocks of assets, rather than flows, in determining asset prices. dominant methodology used by economists, since flows are hard to analyse, especially during inflation.

Question 9

What are the shifts in demand for bonds in regard to wealth, during business cycles and recessions?

Answer 9

in a business cycle expansion with growing income and wealth, demand for bonds rise and the demand curve for bonds shift to the right.

In a recession, when income and wealth are falling, the demand for bonds falls, and the demand curve shifts to the left.

Question 10

State the shift in demand curve due to the following:

• Higher expected future interest rates
• Lower expected future interest rates
• increase in expected return on alternative assets
• Increase expected rate of inflation.

Answer 10

Left
right
left
left

Question 11

State the shift in demand curve from the following:

• Increase in riskiness of bonds
• Increase in riskiness of alternative assets

Answer 11

Left
Right

Question 12

What factors cause the supply curve for bonds to shift?

Answer 12

1. Expected profitability of investment opportunities
2. Expected inflation
3. Government budget deficits

Question 13

What is the fisher effect?

Answer 13

When expected inflation rises, interest rates will rise

Question 14

How does the interest rate change due to a business cycle expansion?

Answer 14

• A business cycle expansion shifts the bond supply curve rightward
• bond demand curve shifts rightward, but by a lesser amount
• the price of bonds falls and the equilibrium interest rate rises.

Question 15

Liquidity preference framework?

Answer 15

An alternative model for determining the equilibrium interest rate.

the quantity of bonds and money supplies must equal the quantity of bonds and money demanded.

Bs + Ms = Bd + Md

Question 16

Opportunity cost?

Answer 16

the amount of interest sacrificed by nit holding the alternative asset.

Question 17

Shifts in demand for money: Income Effect

Answer 17

A higher level of income, causes the demand for money at each interest rate to increase and the demand curve shifts to the right

Question 18

Shifts in demand for money: Price-level effect

Answer 18

a rise in the price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right.

(people don’t want to change their consumption, so when there is an increase in price level, there will be an increase in demand for money so demand will shift to the right.)

Question 19

What will shift the supply of money?

Answer 19

An increase in the money supply engineered by the federal reserve will shift the supply curve for money to the right

Question 20

the liquidity effect?

Answer 20

An increase in the money supply lowers interest rates