Topic 16: Money Demand & Supply

Question 1

What are the three roles of money?

Answer 1

• Store of value
• Unit of account
• Medium of exchange

Question 2

What is the double coincidence of wants?

Answer 2

The idea that in an economy without money, consumers would have to buy from people who demand the specific thing they produce.

Question 3

What are the two sources of money demand?

Answer 3

• Transactions
• Portfolio

Question 4

Give the money demand for transactions equation (nominal and real)

Answer 4

M_D^T = PT(y)/V = Pλy/V

Where P is prices

T(y) is transactions, a function of real GDP

and V is the velocity of money

m_D^T = λy/V, of which λ/v is considered constant.

Question 5

What changes portfolio demand for money?

Answer 5

Depends inversely on the opportunity cost of money, the long term interest rate i.

Question 6

Show the balance sheet of a central bank

Answer 6

Assets:

• Domestic credit, government bonds.
• Official foreign reserves

Liabilities

• Monetary base

Question 7

Derive the equation for the money multiplier

Answer 7

M_S = C_M + D = C_M/D x D + D = (1 + c)D

Where C_M is cash balances.

M_B = C_M + R_B = C_M/D x D + R_B / D x D = (c + ρ)D

MM = M_S/M_B = (1+c)/(c+ρ) ~= 4-8

Question 8

Give the cash to deposit & reserve to deposit ratios.

Answer 8

c = C_M/D ρ=R_B/D

Question 9

How does the central bank change the money suppy?

Answer 9

By purchasing/selling bonds or reserves, such that

ΔM_B = ΔDC + ΔR

In what is known as, open market operations.

Question 10

Give the final money demand equation

Answer 10

m_D=m_D(Y(+),i(-))

or mD = MD(Y(+),r(-), π(i)

Can be written as; though we go linear for our model

Question 11

What will happen to real money demadn if there is a rise in the expected rate of inflation?

Answer 11

Households want to avoid the inflation, so they lower their money balances in their portfolios.