Money Supply + Demand

Question 1

Define Money

Answer 1

something generally accepted in payment for G+S or in repayment of Debts
–Money = Cash + Deposits
Currency, Income + Wealth- are NOT Money

Question 2

Define Fiat Money

Answer 2

type of money we use- Cash / Debit Card

Idea of a method of Accounting

Question 3

Name the 3 Functions of Money

Answer 3

1. Medium of Exchange
2. Unit of Account
3. Store of Value

Question 4

What is Medium of Exchange?

Answer 4

Money is universally accepted in exchange for G+S

• Reduces Transaction Costs + promotes Specialisation
• • Eliminates need to find Double Coincidence of Needs

Question 5

What are the 5 requirements of money for Medium of Exchange?

Answer 5

Easily Standardised
Widely Accepted
Divisible
Easy to Carry
Must NOT Deteriorate easily

Question 6

What is Unit of Account?

Answer 6

Used to Measure value in the economy

Reduces Transaction Costs- Value of Goods are expressed in terms of Money

Question 7

For Money to be Used as a Unit of Account, what property must it have?

Answer 7

Must be Easily Divisible

Question 8

What is Store of Value?

Answer 8

Money must be able to hold its value over time
Allows Saving of Purchasing Power over time
–Means you don’t have to spend money immediately

Question 9

What is the Advantage of Money?

Answer 9

It is the MOST LIQUID Asset

Question 10

What is the Disadvantage of Money?

Answer 10

Value of Money depends on the Price Level- Loses Value with Inflation
–Hyperinflation- Inflation > 50% per month

Question 11

What is the C.Bs Role in Money Supply?

Answer 11

Issue Notes + Coins
Conduct Monetary Policy to control Inflation
Act as a Lender of Last Resort + is the Bank’s Bank

Question 12

What is the Govs.Incentive to make C.B Monopoly Supplier of Notes?

Answer 12

C.B becomes a Source of Revenue for Bank

–Issue of New Notes, those that do not Exchange old Notes lose Money and Revenue goes to Gov.

Question 13

What is the Monetary Base (B)?

Answer 13

The type of Money the C.B prints

Stock of High-powered Money

Question 14

What is the Equation for the Monetary Base?

Answer 14

Monetary Base = Quantity of Notes+Coins in Circulation + Quantity Held by Banking System (Reserves)
B = C + R

Question 15

What type of Money does NOT Count as part of Monetary Base?

Answer 15

‘Electronic Money’- e.g. Money in Current Accounts

Question 16

How do we get the Total Level of Money?

Answer 16

MONEY MULTIPLIER

Monetary Base—> Money Multiplier–> MONEY

Question 17

What is the driver of the Money Multiplier?

Answer 17

Multiple Deposit Creation

Question 18

Define the Money Multiplier (m)

Answer 18

Level of Money Supply (M) for a given level of the Monetary Base (B)
M = m x B
Money here is defined as just Currency + Checkable Deposits (M1)

Question 19

What is the function of the Multiplier defined as?

Answer 19

(CR + 1) / (CR + RR),

CR = Currency Ratio, RR = Reserve Ratio

Question 20

Define Currency Ratio

Answer 20

how much Currency (C) people hold as a fraction of their Demand Deposits (D)
M = C + D, Money Supply = Currency + Demand Deposits
B = C + R, Monetary Base = Currency + Reserves

Question 21

What does Money Supply / Monetary Base (M/B) equal?

Answer 21

Money Multiplier
M/B = (C + D) / (C + R)
–> M/B = [(C/D) + 1] / [(C/D) + (R/D)], C/D = Currency Ratio R/D = Reserve Ratio
–> m = (cr + 1) / (cr + rr)—-> M/B = m (M = m x B)

Question 22

What is the Real Money Supply defined as?

Answer 22

M/P, Money Supply / Price Level

Question 23

What assumptions do we make when looking at the Real Money Supply?

Answer 23

Analyse Money Market in S.R
–Treat the Price Level, P, as Fixed
C.B can Completely control Nominal Money Supply (M)
M/P = Real Money Supply in Economy, determined by C.B

Question 24

Why is holding Money Costly?

Answer 24

Money does NOT pay Interest- Could hold Bonds, Property, Equity etc. instead which pay Interest or Appreciate

Question 25

If Money is costly, why do we still choose to hold it?

Answer 25

People like LIQUIDITY

Question 26

What is Liquidity Preference Theory defined as?

Answer 26

People prefer to hold Cash as it is LIQUID

Question 27

What are the 3 Motives for the Liquidity Preference Theory?

Answer 27

Transactions Motive
Precautionary Motive
Asset Motive

Question 28

What is the Transactions Motive?

Answer 28

Money is the least costly way of Financing Daily purchases

–This Implies Money Demand should Increase in Income + Decrease in Real Interest Rates

Question 29

What is the Precautionary Motive?

Answer 29

We are unsure about When + How much we will have to Spend in the Future
–This Implies Money Demand Increases in Income, ceteris paribus

Question 30

What is the Asset Motive?

Answer 30

Money does NOT bear Interest, so it is SAFE compared to other Assets

• -This Implies- a POSITIVE Relationship between Money Demand and Income
• NEGATIVE Relationship between Money Demand and Real Interest Rates

Question 31

What does Liquidity Preference Theory say about Money Demand?

Answer 31

Money Demand depends POSITIVELY on Income and NEGATIVELY on Interest Rates
(M/P)d = L(Y, r), this is a SR Theory so Nominal + Real IR are Identical

Question 32

What does Money Supply depend on?

Answer 32

M.S depends on How much Money C.B circulates- this is Independent of Income or Interest Rates
(M/P)s = M/P

Question 33

Where is the Money Market in Equilibrium?

Answer 33

(M/P)s = (M/P)d
M/P = L(Y, r)