Econ 101: Financial Market & IS-LM Model

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Questions and Answers

What is the main purpose of money?

To measure wealth

To store value over time

To serve as a liquid asset for transactions (correct)

To represent financial investments

Which of the following defines financial investment?

Investing in short-term high-quality assets

Buying stocks or bonds (correct)

Saving after-tax income

The purchase of machinery

What happens to the demand for money as the interest rate increases?

It becomes unpredictable

It decreases (correct)

It increases significantly

It remains constant

How is nominal income measured?

In current dollars only Signup and view all the answers

What are transaction costs primarily associated with?

Buying or selling bonds Signup and view all the answers

What does the term 'wealth' refer to?

The total value of all owned assets Signup and view all the answers

What is a characteristic of money market funds?

They invest in short-term, high-quality financial assets Signup and view all the answers

What is the relationship between transaction level and nominal income?

Transaction level is proportional to nominal income Signup and view all the answers

What characterizes aggregate demand in an economy?

The total amount of goods and services that households, businesses, and the government are willing to buy at various price levels. Signup and view all the answers

In what situation would aggregate demand increase according to the provided example?

When the price of concert tickets falls from ₱1,400 to ₱200. Signup and view all the answers

What does the Keynesian Cross model illustrate?

The connection between total spending and total output in an economy. Signup and view all the answers

How does the concept of the 'invisible hand' explain market behavior?

The economy corrects itself over time without external influence. Signup and view all the answers

What drives the IS-LM model?

The relationship between interest rates and output in the goods and money market. Signup and view all the answers

What defines aggregate supply within an economy?

The amount of goods and services producers are willing to sell at different price levels. Signup and view all the answers

Which scenario would likely reduce aggregate supply?

An increase in production costs for farmers. Signup and view all the answers

What is the purpose of bank reserves?

To manage daily fluctuations and meet regulatory requirements. Signup and view all the answers

What does the IS Curve represent in the context of Keynesian Economics?

The relationship between interest rates and output in the goods market. Signup and view all the answers

What outcome is likely when higher interest rates are implemented in an economy?

Reduced borrowing and less spending. Signup and view all the answers

How does the multiplier effect function in an economic context?

It amplifies the impact of initial government spending through consumer behavior. Signup and view all the answers

What does liquidity preference primarily illustrate?

The tendency to hold cash rather than invest when interest rates are high. Signup and view all the answers

In the IS-LM model, what does equilibrium determine?

The economy's equilibrium GDP and interest rate. Signup and view all the answers

What does real income indicate?

Income adjusted for inflation Signup and view all the answers

What occurs during an expansionary open market operation?

Central bank buys bonds Signup and view all the answers

What is meant by the term 'zero lower bound'?

When interest rates are too low to stimulate the economy Signup and view all the answers

Which of the following describes financial intermediaries?

Institutions that collect funds to invest or lend Signup and view all the answers

What impact does a contractionary open market operation have?

Lowers bond prices Signup and view all the answers

What does a central bank's balance sheet represent?

Assets and liabilities of the central bank Signup and view all the answers

What is the role of daily cash flow management?

Handling cash inflows and outflows Signup and view all the answers

What is a liquidity trap?

When monetary policy becomes ineffective at low rates Signup and view all the answers

Study Notes

Financial Markets Overview

Saving: Portion of after-tax income reserved rather than spent.
Money: A liquid asset that facilitates transactions.
Investment: Acquiring new capital goods like machinery and buildings; does not yield interest.

Types of Money

Coins: Serve as mediums of exchange for goods and services.
Checkable Deposits: Demand deposit accounts enabling check writing.
Money Market Funds: Investment funds specializing in short-term, high-quality financial assets.

Wealth and Demand for Money

Wealth: Total value of all owned assets.
Demand for Money: Total monetary amount individuals and firms wish to hold for transactions.
Bonds: Financial instruments that yield interest but are not used for transactions.

Income Definitions

Nominal Income: Total income in current dollars, unadjusted for inflation.
Real Income: Income adjusted for inflation, reflecting purchasing power.
Equilibrium in Financial Markets: Achieved when money supply meets money demand, stabilizing the economy.

Banking and Monetary Operations

Central Bank Balance Sheet: Displays the assets and liabilities of the central bank.
Expansionary Open Market Operations: Central bank purchases bonds to increase money supply, raise bond prices, and lower interest rates.
Contractionary Open Market Operations: Involves selling bonds to decrease money supply, which lowers bond prices and raises interest rates.

Financial Intermediaries and Liquidity

Financial Intermediaries: Institutions pooling funds from individuals for investment or loans.
Liquidity Trap: Occurs at the zero lower bound, rendering traditional monetary policy ineffective.

Aggregate Demand and Supply

Aggregate Demand (AD): Total desired goods and services across households, businesses, and government at various price levels.
Aggregate Supply (AS): Total amount of goods and services offered by producers at different price levels.

Keynesian Economics

Invisible Hand: Concept that markets self-correct without government interference.
Keynesian Cross: Model illustrating aggregate demand versus total output.

IS-LM Model

IS Curve: Relates interest rates and output in the goods market, showing equilibrium where investment equals savings.
LM Curve: Represents money market equilibrium.
Equilibrium in IS-LM Model: Intersection of IS and LM curves determines economy's GDP and interest rate.

Economic Effects

Multiplier Effect: Initial government spending cycles through the economy, boosting overall economic activity.
Interest Rates and Economic Activity: Lower rates encourage borrowing and spending; higher rates hinder them, affecting overall demand.

General Concepts

Liquidity Preference: Preference for holding cash rather than investing when interest rates are high.
Transaction Costs: Costs linked to buying/selling bonds, influencing market dynamics.

Monetary Policies

Regulatory Requirements: Central bank mandates that ensure banks maintain certain reserve levels.
Loans: Money lent by banks to individuals and firms, significantly contributing to bank assets.

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Description

Explore key concepts in Financial Markets and the IS-LM Model through this quiz. This material is based on the University of the Philippines, Diliman Extension Program in Pampanga. Test your understanding of important economic principles and their applications.