IS-MP and Interest Flashcards
Explain the relationship between the Demand for Money. Draw a graph.
There is an inverse relationship between nominal interest rates and the quantity of money demanded.
Nominal interest rate = real interest rate + expected inflation rate
This inverse relationship is caused by a couple of reasons:
People demand a certain amount of money or liquid asset.
Explanation: The opportunity cost of holding wealth in the form of money instead of in the form of other assets is the nominal interest rate. If interest rates are low, people demand more money because the opportunity cost is lower. If interest rates are high, people demand less money because the opportunity cost is higher.
What are the shifters of Money Demand?
Price Level
Real GDP
Transaction Costs
What happens to the IS-MP model when there is a decrease in productivity that drives prices up in a economy?
This would cause goods and services to become more expensive which means that as consumers we need more money to make these purchases. This would lead to an increase in money demand.
What happens to the IS-MP model when consumption levels fall as the economy enters a recession
This would cause a decrease in the amount of goods and services being purchased which means that we do not need as much money. This would lead to a decrease in money demand.
Where does supply of money come from?What tools do they use?
The monetary base of a nation is determined by the country’s central bank (FED). This means that the money supply is independent of the nominal interest rate. The supply of money will remain constant regardless of the nominal interest rate. The only way the money supply will change is as a result of monetary policy
There are three tools that the FED uses to influence the money supply. These include the reserve requirement, the discount rate, open market operations (the buying and selling of bonds), and the federal funds rate
What happens to the tools when they increase or decrease money supply?
Increase in money supply: Decrease Discount rate, Decrease reserve ratio, buy bonds, decrease the Federal Funds Rate
Decrease in money supply: Increase the discount rate, increase reserve ratio, buy bonds, increase the Federal Funds Rate
Draw the Money Supply increasing and decreasing.
Decrease Money Supply left, increase money supply right
Explain Money Market Equilbirum. Draw it all LABELS
Money market equilibrium is achieved when the interest rate at which the quantity of money demanded equals the quantity of money supplied. The nominal interest rate is the interest rate on the vertical axis and the quantity of money is on the horizontal axis.
Explain Investment Demand? What Relationship is there?
Investment demand is the desired quantity of investment spending by firms across the economy on physical capital and other resources for the purpose of future productivity/profitability
There is an inverse relationship between the nominal interest rate and the quantity of investment demanded. When the nominal interest rate falls, we see an increase in the quantity of investment demanded. The opposite is also true. When the nominal interest rate rises, we see a decrease in the quantity of investment demanded.
