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Macroeconomic Theory > Chapter 7 > Flashcards

Chapter 7 Flashcards

1
Q

Characterstics of assets

A
  • Expected return
  • Risk
  • Time to maturity
  • Liquidity
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2
Q

What is expected return?

A

The expected rate of increase in the value of asset per unit of time

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3
Q

How does the expected return affect the demand for assets?

A

All else equal, the higher an asset’s expected return, the more desirable the asset is and the more of it holders of wealth will want to own.

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4
Q

What is risk in the context of asset allocation?

A

The uncertainty about the return of the asset (i.e. changes between actual and expected return).

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5
Q

How does the level of risk affect the return of an asset?

A

All else equal, the higher the risk of the asset, the higher its return.

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6
Q

What is liquidity in the context of asset allocation?

A

The ease and quickness with which it can be exchanged for goods and services or other assets.

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7
Q

Why is liquidity an important consideration for holders of wealth?

A

Liquidity provides flexibility for holder of wealth.

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8
Q

How does the level of liquidity of an asset affect its attractiveness to holders of wealth?

A

All else equal, the more liquid an asset is, the more
attractive it will be to holder of wealth.

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9
Q

What is time to maturity of a financial security?

A

The amount of time until a financial security matures and investor is repaid his/her principal.

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10
Q

How does the time to maturity of an asset affect its level of risk

A

Longer term assets are risker than shorter term assets, thus, their return should be higher.

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11
Q

What is the trade-off involved in the portfolio allocation decision?

A

The portfolio allocation decision involves a trade-off between the four characteristics of assets: expected return, risk, liquidity, and time to maturity.

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12
Q

How does diversification impact the overall risk of a portfolio?

A

Diversification involves spreading out investments in different assets, which reduces the overall risk of the portfolio.

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13
Q

What is an individual’s demand for an asset?

A

An individual’s demand for an asset is the amount of that asset that a holder of wealth decides to include in their portfolio.

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14
Q

What is the definition of Demand for Money?

A

Demand for Money is the quantity of monetary assets, such as cash and checking accounts, that people choose to hold in their portfolios

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15
Q

What are the factors that affect the demand for money?

A
  • Interest Rates
  • Wealth
  • Payment Technologies
  • Liquidity of Alternative assets
  • Real Income
  • Risk
  • Price level
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16
Q

What is the relationship between the price level and nominal money demand?

A

A higher price level increases the nominal demand for money. All else equal, the nominal money demand is proportional to the price level.

Since a higher Price level (P) raises the need for liquidity (more
dollars to conduct transactions)

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17
Q

What is the relationship between real income and nominal money demand in the Demand for Money theory?

A

A higher real income leads to more transactions and greater need for liquidity, resulting in an increase in nominal money demand. However, an increase in money demand is not proportional to an increase in real income, as aggregate money demand grows more slowly than income, all else equal.

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18
Q

Why does an increase in real income not result in a proportional increase in money demand?

A

because when income rises, people tend to hold more of their wealth in interest-earning assets such as bonds, stocks, and other securities instead of keeping all their wealth in liquid assets like cash and checking accounts

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19
Q

What is the effect of an increase in expected return on money (i^m) on money demand?

A

An increase in expected return on money (i^m) increases money demand

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20
Q

What is the effect of an increase in expected return on alternative assets (I) on money demand?

A

An increase in expected return on alternative assets (I) decreases money demand

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21
Q

What is the Money Demand Function?

A

Md = P * L (Y,i)

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22
Q

ًWhat does the Md denote in the Money demand function?

A

Aggregate nominal demand for money

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23
Q

What does L (Y,i) denote in the money demand function?

A

In the money demand function, L(Y,i) denotes the liquidity preference function, which represents the relationship between the nominal demand for money (Md) and the real income (Y) and nominal interest rate (i) of alternative assets.

24
Q

What does the equation
“Md/ P = L (Y, r+ π^e)” represent?

A

The equation represents the real money demand function, where Md/P represents the demand for real balances, L represents the liquidity preference function, Y represents real income, r represents the real interest rate, and π^e represents the expected inflation rate.

25
Q

What factors does the real money demand depend on?

A

The real money demand depends on real income and the nominal interest rate.

26
Q

Other Factors Affecting Money Demand

What is the effect of an increase in wealth on money demand with constant income?

A

When wealth increases, part of the extra wealth will be held as money…. Increasing demand for money

27
Q

How does an increase in the risk of alternative assets affect the demand for money?

A

People demand safer assets Md increases

28
Q

What happens to the demand for money when people demand safer assets due to an increase in the risk of alternative assets?

A

Increases

29
Q

What happens to the demand for money when there is an increase in the risk of money due to erratic inflation?

A

The demand for money decreases as people seek inflation hedges.

30
Q

What is the relationship between the liquidity of alternative assets and the demand for money?

A

The more quickly and easily alternative assets can be converted into cash, the less the need to hold money and hence the less the demand for money.

31
Q

How does competition and innovation in financial markets affect the demand for money?

A

Competition and Innovation in financial markets made alternatives to money more liquid and hence reduced demand for money.

32
Q

How has the improvement of payment technologies affected the demand for money?

A

Improvement in payment technologies (credit cards, ATMs,..) reduced the need to hold money, resulting in a decline in money demand.

33
Q

What is meant by the term “Asset Market”?

A

Refers to the entire set of markets in which people
buy and sell real and financial assets

including, for example, gold, houses, stocks and bonds.

34
Q

Define demand for any asset in the context of Asset Market.

A

Demand for any asset is the quantity of assets that holders of wealth want in their portfolio

35
Q

What is meant by the supply of any asset in Asset Market?

A

Supply of any asset is the quantity of the asset that is available (fixed at any point in time)

36
Q

When is an Asset Market considered to be in equilibrium?

A

ًًWhen quantity of each asset
demanded equals its available supply

37
Q

What are the two categories of assets in the Asset Market Equilibrium?

A

The two categories of assets are money and nonmonetary assets.

38
Q

What does the money category of assets include?

A

The money category includes assets that can be used in payment such as cash and checking account.

39
Q

Do all money have the same risk, liquidity and nominal interest?

A

Yes, all money have the same risk, liquidity and nominal interest (i^m).

40
Q

What is the fixed money supply in the Asset Market Equilibrium?

A

The fixed money supply is denoted by the letter M.

41
Q

What does the nonmonetary assets category include?

A

The nonmonetary assets category includes all assets other than money such as stocks, bonds, and land.

42
Q

Do all nonmonetary assets have the same risk, liquidity and nominal interest?

A

Yes, all nonmonetary assets have the same risk, liquidity and nominal interest (i = r + π^e).

43
Q

What is the fixed nominal supply of nonmonetary assets in the Asset Market Equilibrium?

A

The fixed nominal supply of nonmonetary assets is denoted by the letter NM.

44
Q

What is the assumption made to derive asset market equilibrium?

A

The assumption made to derive asset market equilibrium is that an individual’s wealth is divided between money and nonmonetary assets.

45
Q

What are the variables used to express an individual’s nominal wealth?

A

The variables used to express an individual’s nominal wealth are the nominal demand for money (m^d) and the nominal demand for nonmonetary assets (nm^d).

46
Q

How is aggregate nominal wealth expressed in the context of asset market equilibrium?

A

Aggregate nominal wealth in the context of asset market equilibrium is expressed as the sum of the nominal demand for money (M^d) and the nominal demand for nonmonetary assets (NM^d).

47
Q

What are the variables used to express aggregate nominal wealth in the context of asset market equilibrium?

A

The variables used to express aggregate nominal wealth in the context of asset market equilibrium are the nominal supply of money (M) and the nominal supply of nonmonetary assets (NM).

48
Q

What is the equation used to express excess demand in the context of asset market equilibrium?

A

The equation used to express excess demand in the context of asset market equilibrium is (M^d - M) + (NM^d - NM) = 0.

49
Q

What is the excess demand for money in the context of asset market equilibrium when M^d = M?

A

When M^d = M, the excess demand for money in the context of asset market equilibrium is 0, while the excess demand for nonmonetary assets is also 0 (NM^d - NM = 0).

50
Q

What is the condition for asset market equilibrium in the context of two types of assets?

A

The condition for asset market equilibrium in the context of two types of assets is that the quantity of money supplied must equal the quantity of money demanded.

51
Q

What is the assumption made about the number of asset types in asset market equilibrium?

A

The assumption made in the context of asset market equilibrium is that there are only two types of assets.

52
Q

What is the role of the quantity of money supplied and demanded in asset market equilibrium?

A

The quantity of money supplied and demanded is crucial to determining asset market equilibrium, as the equilibrium is established when the quantity of money supplied equals the quantity of money demanded

53
Q

What is the equation used to express the asset market equilibrium condition?

A

The equation used to express the asset market equilibrium condition is M/P = L(Y, r + π^e), where M is the nominal supply of money, P is the price level, L is the demand for money function, Y is the level of income or output, r is the interest rate, and π^e is the expected rate of inflation.

54
Q

What variables are assumed to be constant in the asset market equilibrium condition?

A

The variables assumed to be constant in the asset market equilibrium condition are M and π^e.

55
Q

How is the price level (P) determined in the asset market equilibrium condition?

A

In the asset market equilibrium condition, the price level (P) is determined by the nominal supply of money (M) and the demand for money function (L), which is a function of income (Y), the interest rate (r), and expected inflation (π^e). Specifically, P = M / L(Y, r + π^e).

Macroeconomic Theory (8 decks)

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