Wk 5 - The Asset Market, Money, and Prices

Question 1

Define money

Answer 1

Assets that are widely used and accepted as payment.

Question 2

Medium of exchange

Answer 2

An object that is typically accepted in exchange for goods and services.

Question 3

Unit of account

Answer 3

An agreed measure for stating the prices of goods and services.

Question 4

Store of value

Answer 4

• Money can be stored for a period of time and later exchanged for goods and services.
• Money can be utilised to hold wealth.
• Most people use money only as a store of value for a short period and for small amounts because it earns less interest than money in the bank.

Question 5

Commodity money

Answer 5

Valuable, easily standardised and divisible commodities (e.g. precious metals, cigarettes).

Question 6

Fiat money

Answer 6

Paper money decreed by governments as legal tender.

Question 7

Cheques

Answer 7

An instruction to your bank to transfer money from your account (not money).

Question 8

Debit cards

Answer 8

Works like a paper cheque, only faster (not money).

Question 9

Credit cards

Answer 9

A special type of ID card that gets you an instant loan (not money).

Question 10

Stored-value card (smart card)

Answer 10

A physical card that has an embedded integrated chip that acts as a security token (not money).

Question 11

EFTPOS

Answer 11

Debit card transaction system Electronic Funds Transfer at Point of Sale (not money).

Question 12

E-Cash

Answer 12

An electronic equivalent of paper banknotes and coins, an electronic currency (money).

Question 13

Bitcoin and cryptocurrencies

Answer 13

• Do not exist in physical form, only as a records in a computer system.
• Allows anonymous transactions.

Question 14

M1 monetary aggregate

Answer 14

• Currency and traveller’s cheques held by the public.
• Transaction accounts on which cheques may be drawn.
• All components are used in making payments.

Question 15

M2 monetary aggregate

Answer 15

Adds to M1 other assets that are not so liquid.

Question 16

Uses of monetary policy

Answer 16

• Manage economic activity and achieve price stability.
• Fight unemployment and achieve full employment.
• Promote stable output growth and promote the general welfare of the people.

Question 17

How does the central bank of a country increase and decrease the money supply?

Answer 17

Increase: Use newly printed money to buy financial assets from the public - an open-market purchase.
Decrease: Sell financial assets to the public to remove money from circulation - an open-market sale

Question 18

Rate of return

Answer 18

An asset’s increase in value per unit of time.

Question 19

Risk

Answer 19

• Degree of uncertainty.
• People prefer assets with low risk.
• Risk premium: the amount by which the expected return on a risky asset exceeds the return on an otherwise comparable safe asset.

Question 20

Liquidity

Answer 20

• The ease and quickness with which an asset can be traded.

Question 21

Time to maturity

Answer 21

• Amount of time until a financial security matures and the investor is repaid the principal.

Question 22

Types of assets

Answer 22

• Money: low return, low risk and high liquidity.
• Bonds: higher return, more risk and less liquidity.
• Stocks: pay dividends and can have capital gains and losses, and are much more risky than money.
• Ownership of a small business: very risky and not liquid at all, but may pay a very high return.
• Housing: provides housing services and potential for capital gains, but is quite illiquid.

Question 23

Demand for money

Answer 23

• Quantity of monetary assets people want to hold in their portfolios
• Depends on expected return, risk, and liquidity.
• Price level, real income and interest rates.

Question 24

Price level

Answer 24

• Higher the price level, the more money you need for transactions.

Question 25

Real income !!!

Answer 25

• Money demand rises as real income rises.
• Money demand isn’t proportional to real income as higher-income individuals use money more efficiently.

Question 26

Interest rates

Answer 26

• Increase in interest rates or return on non-monetary assets decreases the demand for money.
• Increase in the interest rate on money increases money demand.

Question 27

Other factors affecting money demand

Answer 27

• Wealth: rise in wealth may increase money demand, but not by much.
• Risk: increased riskiness in the economy may increase money demand.
• Liquidity of alternative assets: deregulation, competition, and innovation have given other assets more liquidity, reducing the demand for money.
• Payment technologies: credit cards, ATMs, and other financial innovations reduce money demand.

Question 28

Elasticity of money demand

Answer 28

The percent change in money demand caused by a one percent change in some factor.

Question 29

Income elasti ity of money demand

Answer 29

Positive: higher income increases money demand
Less than one; higher income increases money demand less than proportionately

Question 30

Interest elasticity of money demand

Answer 30

Small and negative: higher interest rate on nonmonetary assets reduces money demand slightly.

Question 31

Price elasticity of money demand

Answer 31

Unitary, which means money demand is proportional to the price level

Question 32

Velocity

Answer 32

Measures how much money “turns over” each period

Question 33

Quantity theory of money

Answer 33

Real money demand is proportional to real income.