Tobin’s Model of Portfolio Selection Quiz　ME CP3
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Questions and Answers

Why is there a need for money, as discussed in Chapter 2?

  • To reduce the demand for goods and services
  • To eliminate competition among individuals
  • To create a trustless economy
  • To facilitate barter trade (correct)

    • What is the aim of studying money demand in this chapter?

  • To explain the quantity of money individuals and economies demand (correct)
  • To discuss the history of economic transactions
  • To promote alternative forms of payment
  • To criticize the concept of money demand

    • What does a reduced form equation represent?

  • An equation derived from econometrics
  • An equation based on inventory theory
  • A mixture of both money demand and supply equations (correct)
  • A true money demand equation

    • When will a changing policy stance by the authorities cause the reduced form relationship to alter?

    <p>Never</p> Signup and view all the answers

    What issues need to be addressed before any meaningful interpretation can be taken from empirical results?

    <p>Stationarity, spurious regressions, and co-integration</p> Signup and view all the answers

    What are the four main microeconomic determinants of money demand?

    <p>Income, interest rates, inflation, and output</p> Signup and view all the answers

    Who provided a review of the stability of the demand for money function?

    <p>Judd and Scadding</p> Signup and view all the answers

    What is the importance of studying the demand for money?

    <p>To understand the dynamics of money supply and demand</p> Signup and view all the answers

    What does an individual expect to experience on his bond holdings when he expects the interest rate to rise?

    <p>Capital loss</p> Signup and view all the answers

    In Keynes' assumption, when the interest rate was below what individuals expected in the long run, what form would they put all of their financial wealth in to avoid capital loss?

    <p>Money</p> Signup and view all the answers

    What does the individual want to hold when the interest rate is expected to fall, leading to a capital gain from holding bonds?

    <p>Bonds</p> Signup and view all the answers

    Which function is used to model the transaction demand for money by allowing more flexible assumptions on the expected pattern of expenditures and receipts?

    <p>Step function</p> Signup and view all the answers

    In the Baumol model, what is the objective when managing an inventory of cash and other interest-earning assets?

    <p>Maximize profits or minimize costs</p> Signup and view all the answers

    What determines the cost in the cash manager's cost minimization problem in the Baumol model?

    <p>Interest foregone by holding money and brokerage costs</p> Signup and view all the answers

    What are the elasticities of money demand with respect to income and interest rate earned on alternative assets?

    <p>-1/2 and 1/2</p> Signup and view all the answers

    What type of pattern does the model generate for money holdings in Figure 3.2?

    <p>'Saw tooth' pattern</p> Signup and view all the answers

    In Activity 3.1, what does the diagram show as the optimal number of times to transfer between bonds and money?

    <p>4</p> Signup and view all the answers

    What does T represent in the Baumol model?

    <p>Value of cash manager’s expenditures</p> Signup and view all the answers

    What kind of relationship does average money demand have with brokerage cost, b?

    <p>Positive relationship</p> Signup and view all the answers

    What function is used to model the speculative demand for money?

    <p>Step function</p> Signup and view all the answers

    What are the four main microeconomic determinants of money demand?

    <p>Interest, cost of transfers, price uncertainty, expected pattern of expenditures and receipts</p> Signup and view all the answers

    According to Keynes, what is the transaction demand for money?

    <p>Money needed to buy goods and services as a medium of exchange</p> Signup and view all the answers

    What does the speculative demand for money consider money as?

    <p>An alternative to interest earning assets</p> Signup and view all the answers

    What is the expected pattern of expenditures and receipts related to in terms of money demand?

    <p>Demand for money motives</p> Signup and view all the answers

    What is the main factor affecting the demand for money due to the cost of transfers?

    <p>Brokerage fees</p> Signup and view all the answers

    What does the risk aversion directly influence in terms of money demand?

    <p>Price uncertainty of assets</p> Signup and view all the answers

    In relation to the demand for money, what does interest differentials refer to?

    <p>Difference between the yield on money and interest rates</p> Signup and view all the answers

    Which of the following is NOT a determinant of the demand for apples?

    <p>The price of bananas</p> Signup and view all the answers

    What does a change in the supply of money lead to?

    <p>A change in the value of the determinants of the demand for apples</p> Signup and view all the answers

    In the money demand function M d = f (Y, Ri , W ), what does Y represent?

    <p>Real income</p> Signup and view all the answers

    Why is wealth (W) included in the money demand function?

    <p>It forms the budget constraint on which money holdings depend</p> Signup and view all the answers

    If money demand is homogenous of degree one in prices, what can be re-written as g(y, Ri )?

    <p>$M d = g(y, Ri )$</p> Signup and view all the answers

    What does a low value of b imply in the interest elasticity of money demand?

    <p>A relatively steep LM curve and a larger effect of fiscal policy on output</p> Signup and view all the answers

    What can lead to unexpected and adverse changes in nominal and possibly real factors in the economy?

    <p>Unstable money demand function</p> Signup and view all the answers

    What was observed about Goldfeld's equation in the 1970s?

    <p>It overpredicted real money balances in the US</p> Signup and view all the answers

    'The case of the missing money' was attributed to what factor?

    <p>Greater financial innovation</p> Signup and view all the answers

    'The case of the missing money' was primarily observed in which countries?

    <p>UK and US</p> Signup and view all the answers

    What does a single equation money demand function's misspecification result in?

    <p>Negative results</p> Signup and view all the answers

    What was one possible explanation for the breakdown of money demand equations in the 1970s?

    <p>Greater financial innovation</p> Signup and view all the answers

    According to Tobin’s model of portfolio selection, what is the assumption about the return on money?

    <p>Money has a zero rate of return</p> Signup and view all the answers

    What is one criticism of the inventory theoretic model?

    <p>It assumes perfect knowledge of expenditure and receipts</p> Signup and view all the answers

    In Tobin’s model, what is the proportion of financial wealth held in bonds denoted as?

    <p>$B$</p> Signup and view all the answers

    What does Tobin assume about the variance of the return on money?

    <p>The variance is always zero</p> Signup and view all the answers

    According to Tobin’s model, what is assumed to be riskless?

    <p>Return on money</p> Signup and view all the answers

    What was one problem with Keynes’ original ideas of micro level demand for money?

    <p>Individuals had certain expectations of interest rate movements</p> Signup and view all the answers

    In micro level demand for money, what did Tobin consider money to have in terms of rate of return?

    <p>Zero rate of return</p> Signup and view all the answers

    What did Tobin's portfolio analysis demonstrate about diversifying wealth?

    <p>$\mu$ shifts the lines in the figure resulting in new equilibrium</p> Signup and view all the answers

    What do the indifference curves represent in Tobin's portfolio analysis?

    <p>$B^<em>$ and $1 - B^</em>$</p> Signup and view all the answers

    In macroeconomic determinants of money demand, what does the demand for something allow us to do?

    <p>Predict changes in its supply</p> Signup and view all the answers

    Why has the demand for money attracted much attention according to the text?

    <p>To understand the consequences of changes in its supply</p> Signup and view all the answers

    What can be concluded about Tobin's analysis based on the text?

    <p>It offers insights into how individuals can maximize utility by choosing between assets in a portfolio</p> Signup and view all the answers

    What is the aim of Chapter 3?

    <p>To study the microeconomic determinants of money demand</p> Signup and view all the answers

    What determines the quantity of money that individuals and economies demand?

    <p>The microeconomic determinants of money demand</p> Signup and view all the answers

    According to Tobin’s model of portfolio selection, what is the assumption about the return on money?

    <p>Low variance</p> Signup and view all the answers

    What was one problem with Keynes’ original ideas of micro level demand for money?

    <p>Assumption of constant velocity</p> Signup and view all the answers

    What can lead to unexpected and adverse changes in nominal and possibly real factors in the economy?

    <p>Fluctuations in interest rates</p> Signup and view all the answers

    What does an individual expect to experience on his bond holdings when he expects the interest rate to rise?

    <p>Decreased value of bond holdings</p> Signup and view all the answers

    What is the average money demand, M, positively and negatively influenced by?

    <p>The interest rate earned on alternative assets and the brokerage cost</p> Signup and view all the answers

    In the Baumol model, what are the costs made up of when considering the cash manager's expenditures?

    <p>The brokerage costs and the interest foregone by holding money</p> Signup and view all the answers

    What is the interest elasticity of money demand in the Baumol model?

    <p>-1/2</p> Signup and view all the answers

    In Tobin’s model, what does a low value of b imply in the interest elasticity of money demand?

    <p>Low sensitivity of money demand to changes in the interest rate earned on alternative assets</p> Signup and view all the answers

    What does a single equation money demand function's misspecification result in?

    <p>Inaccurate predictions of money demand</p> Signup and view all the answers

    What does Tobin’s model explicitly model in terms of the transactions demand for money?

    <p>Transaction frequency</p> Signup and view all the answers

    In Tobin’s model, what is the proportion of financial wealth held in bonds denoted as?

    <p>$B_t$</p> Signup and view all the answers

    What does a reduced form equation represent?

    <p>$Y$ and $R_i$ as exogenous variables</p> Signup and view all the answers

    Which type of analysis can incorporate a precautionary motive for money holdings?

    <p>Transaction demand for money analysis</p> Signup and view all the answers

    What are the two forms of costs included in the Baumol model?

    <p>Brokerage fees and interest foregone by holding money</p> Signup and view all the answers

    What does Tobin consider when modeling transactions demand for money?

    <p>Transaction frequency</p> Signup and view all the answers

    Why might an equation relating real money balances, income, and interest rates not represent a true money demand equation?

    <p>It may be a reduced form equation, representing a mixture of money demand and supply equations.</p> Signup and view all the answers

    What issue needs to be addressed before any meaningful interpretation can be taken from empirical results in the context of money demand?

    <p>All of the above</p> Signup and view all the answers

    In Tobin’s portfolio selection model, what does he assume about the variance of the return on money?

    <p>It is constant.</p> Signup and view all the answers

    What does the demand for money allow us to do according to the text?

    <p>Make monetary transactions.</p> Signup and view all the answers

    What issue led to the breakdown of estimated ‘demand’ function in the US from 1979 to 1982?

    <p>Changing policy stance by the authorities</p> Signup and view all the answers

    What is one criticism of using overly simplified econometrics in studying money demand according to the text?

    <p>It may lead to spurious regressions.</p> Signup and view all the answers

    In Tobin's model of portfolio selection, what is the assumption about the return on money?

    <p>It is considered riskless</p> Signup and view all the answers

    What does the speculative demand for money consider money as?

    <p>A risky asset</p> Signup and view all the answers

    According to Tobin’s model, what is assumed to be riskless?

    <p>Money</p> Signup and view all the answers

    What function is used to model the transaction demand for money by allowing more flexible assumptions on the expected pattern of expenditures and receipts?

    <p>Baumol model</p> Signup and view all the answers

    What was one problem with Keynes’ original ideas of micro level demand for money?

    <p>Individuals held expectations of interest rate movements with certainty</p> Signup and view all the answers

    What does a low value of brokerage fee (b) imply in the interest elasticity of money demand?

    <p>It increases the interest elasticity of money demand</p> Signup and view all the answers

    What are the macroeconomic determinants of money demand modeled as a function of?

    <p>Interest differentials, cost of transfers, asset price uncertainty, and pattern of expenditures and receipts</p> Signup and view all the answers

    What was observed about Goldfeld's equation in the 1970s?

    <p>It failed to capture the complexity of money demand</p> Signup and view all the answers

    According to the text, why is there a need for studying the demand for money?

    <p>'We study the demand for something in order to be able to predict the consequences of changes in its supply'</p> Signup and view all the answers

    In relation to the demand for money, what does interest differentials refer to?

    <p>The difference in interest rates between different financial assets</p> Signup and view all the answers

    What are the main microeconomic determinants of money demand?

    <p>Transaction costs, brokerage fees, and liquidity preferences</p> Signup and view all the answers

    What does Tobin assume about the variance of the return on money?

    <p>It is zero</p> Signup and view all the answers

    What are the four main microeconomic determinants of money demand?

    <p>Interest differentials, cost of transfers, price uncertainty of assets, and expected pattern of expenditures and receipts</p> Signup and view all the answers

    What did Keynes break down the demand for money into?

    <p>Transactions, precautionary, and speculative motives</p> Signup and view all the answers

    What is the relationship between the cost of transfers and the demand for money?

    <p>Demand for money will be a positive function of transfer costs</p> Signup and view all the answers

    What is the importance of studying the demand for money?

    <p>To understand the factors influencing individuals' and firms' holdings of money balances</p> Signup and view all the answers

    What is Tobin's assumption about the return on money?

    <p>Tobin assumed that the return on money is riskless</p> Signup and view all the answers

    What are the elasticities of money demand with respect to income and interest rate earned on alternative assets?

    <p>Income elasticity is positive; interest elasticity is negative</p> Signup and view all the answers

    'The case of the missing money' was attributed to what factor?

    <p>Breakdown of estimated money demand equations</p> Signup and view all the answers

    What does a reduced form equation represent?

    <p>A simplified representation of a complex model or system</p> Signup and view all the answers

    'The transaction demand for money' is essentially needed for what purpose?

    <p>'The transaction demand for money' is essentially needed as a medium of exchange for goods and services</p> Signup and view all the answers

    'Precautionary money balances' are simply holdings of money kept for what purpose?

    <p>'Precautionary money balances' are simply holdings of money kept in case of emergencies</p> Signup and view all the answers

    'Speculative demand for money' considers money as what?

    <p>'Speculative demand for money' considers money as an alternative to interest-earning assets</p> Signup and view all the answers

    What did Tobin assume about the variance of the return on money?

    <p>Tobin assumed that the variance of the return on money is lower than other assets</p> Signup and view all the answers

    What is the main focus of the money demand function?

    <p>Evaluating the opportunity cost of holding money</p> Signup and view all the answers

    What does a low value of b in the interest elasticity of money demand imply?

    <p>Monetary policy has a larger effect on output than fiscal policy</p> Signup and view all the answers

    What are the two important parameters of the money demand function?

    <p>Price level and real income</p> Signup and view all the answers

    What did Goldfeld's equation suggest during the 1970s?

    <p>There should be more money in circulation than there actually was</p> Signup and view all the answers

    What was a possible explanation for the breakdown of money demand equations in the 1970s?

    <p>Greater financial innovation and high inflation</p> Signup and view all the answers

    What does the stability of money demand function determine?

    <p>The statistical analysis of relevant data</p> Signup and view all the answers

    What is included in the particular aggregate money demand function?

    <p>Nominal income and real interest rate</p> Signup and view all the answers

    What does the interest elasticity of money demand determine?

    <p>Whether monetary or fiscal policy is more powerful</p> Signup and view all the answers

    What does Y act as in the demand for money function?

    <p>A proxy for the level of transactions undertaken.</p> Signup and view all the answers

    If money demand is homogenous of degree one in prices, what can be re-written as g(y, Ri )?

    <p>M d = g (Y, Ri , W )</p> Signup and view all the answers

    What does W represent in the money demand function?

    <p>The budget constraint on which the choice of money holdings depends.</p> Signup and view all the answers

    What is the main focus of Chapter 3?

    <p>To explain the quantity of money individuals and economies demand</p> Signup and view all the answers

    In Tobin’s model of portfolio selection, what is assumed about the return on money?

    <p>It is riskless</p> Signup and view all the answers

    What does the stability of the money demand function determine?

    <p>The stability of the macroeconomic demand for money function</p> Signup and view all the answers

    What was observed about Goldfeld's equation in the 1970s?

    <p>It failed to capture the transaction and speculative demand for money</p> Signup and view all the answers

    What are the four main microeconomic determinants of money demand?

    <p>Interest rate, wealth, expected inflation, income</p> Signup and view all the answers

    In relation to the demand for money, what does interest differentials refer to?

    <p>The difference in interest rates between different assets</p> Signup and view all the answers

    In the context of the money demand equation, what can lead to the breakdown of the estimated 'demand' function?

    <p>Changing policy stance by the authorities</p> Signup and view all the answers

    What is a reduced form equation in the context of money demand equation?

    <p>A mixture of both money demand and supply equations</p> Signup and view all the answers

    What needs to be addressed before any meaningful interpretation can be taken from empirical results in the context of money demand equation?

    <p>Stationarity and co-integration</p> Signup and view all the answers

    According to the text, what are the main microeconomic determinants of money demand?

    <p>Interest rates, inflation, and output</p> Signup and view all the answers

    What can cause the breakdown of the estimated 'demand' function in the context of money demand equation?

    <p>A changing policy stance by the authorities</p> Signup and view all the answers

    What was used up until the last couple of decades in the context of money demand equation?

    <p>Overly simplified econometrics</p> Signup and view all the answers

    What is the main focus of the stability of money demand?

    <p>Determining if the money demand equation is stable</p> Signup and view all the answers

    What was one problem with the demand for money functions in the 1970s?

    <p>The overprediction of real money balances</p> Signup and view all the answers

    What did Goldfeld's equation suggest during the 1970s?

    <p>There should be more money in circulation than there actually was</p> Signup and view all the answers

    What was a possible explanation for the negative results of the 1970s?

    <p>Greater financial innovation and increased interest rates</p> Signup and view all the answers

    What are the two important parameters of the money demand function?

    <p>Interest rates and real income</p> Signup and view all the answers

    What does the interest elasticity of money demand determine?

    <p>The effect on output from monetary or fiscal policy</p> Signup and view all the answers

    According to Goldfeld, what was notable about a conventional formulation of the money demand function?

    <p>'The conventional equation exhibits no marked instabilities'</p> Signup and view all the answers

    'The case of the missing money' refers to which situation?

    <p>'The case where there should be more money in circulation than there actually was'</p> Signup and view all the answers

    'Speculative demand for money' considers money as what?

    <p>A store of value, medium of exchange, and asset yielding a return</p> Signup and view all the answers

    What does Tobin's model assume about the return on money?

    <p>It assumes no rate of return on holding money</p> Signup and view all the answers

    What is the aim of Chapter 3?

    <p>To explain in detail the methods used to estimate money demand functions</p> Signup and view all the answers

    In the Baumol model, what is the objective when managing an inventory of cash and other interest-earning assets?

    <p>To minimize brokerage fees and the interest foregone by holding money</p> Signup and view all the answers

    What needs to be addressed before any meaningful interpretation can be taken from empirical results in the context of money demand equation?

    <p>Asset price uncertainty</p> Signup and view all the answers

    In Tobin’s model, what does a low value of b imply in the interest elasticity of money demand?

    <p>Low interest elasticity of money demand</p> Signup and view all the answers

    What is the relationship between the cost of transfers and the demand for money?

    <p>Inverse relationship</p> Signup and view all the answers

    What can lead to unexpected and adverse changes in nominal and possibly real factors in the economy?

    <p>Asset price uncertainty</p> Signup and view all the answers

    'Precautionary money balances' are simply holdings of money kept for what purpose?

    <p>Covering transactions and precautionary motives</p> Signup and view all the answers

    'Speculative demand for money' considers money as what?

    <p>Riskless</p> Signup and view all the answers

    'The transaction demand for money' is essentially needed for what purpose?

    <p>To minimize brokerage fees and interest foregone by holding money</p> Signup and view all the answers

    What was observed about Goldfeld's equation in the 1970s?

    <p>It suggested a low interest elasticity of money demand</p> Signup and view all the answers

    What is Tobin's assumption about the return on money?

    <p>It is riskless</p> Signup and view all the answers

    According to Tobin’s model of portfolio selection, what is the assumption about the return on money?

    <p>Riskless</p> Signup and view all the answers

    In relation to the demand for money, what do indifference curves represent in Tobin's portfolio analysis?

    <p>Risk preferences</p> Signup and view all the answers

    What is the main criticism made against the inventory theoretic models?

    <p>They assume perfect knowledge of the pattern of expenditure and receipts.</p> Signup and view all the answers

    In Tobin's model of portfolio selection, what is the assumption about the return on money?

    <p>Money has a zero rate of return and is considered riskless.</p> Signup and view all the answers

    What issue did Keynes' original ideas of micro level demand for money face?

    <p>The assumption that individuals have perfect knowledge of interest rate movements.</p> Signup and view all the answers

    What does Tobin assume about the return on bonds in his model of portfolio selection?

    <p>Bonds have a positive rate of return but are risky due to the possibility of capital gains or losses.</p> Signup and view all the answers

    What is one problem with Keynes’ original ideas of micro level demand for money?

    <p>Individuals held expectations of interest rate movements with certainty.</p> Signup and view all the answers

    What are the four main determinants of money demand at the individual level?

    <p>Interest differentials, cost of transfers, price uncertainty of assets, and the expected pattern of expenditures and receipts</p> Signup and view all the answers

    What did Keynes break down the demand for money into?

    <p>Transactions, precautionary, and speculative motives</p> Signup and view all the answers

    What is the interest elasticity of transactions demand for cash related to?

    <p>The percentage change in cash demand due to a percentage change in the interest rate</p> Signup and view all the answers

    What is the relationship between the cost of transfers and the demand for money?

    <p>As cost of transfers increases, the demand for money increases</p> Signup and view all the answers

    What does Tobin assume about the variance of the return on money?

    <p>It is constant over time</p> Signup and view all the answers

    'Precautionary money balances' are simply holdings of money kept for what purpose?

    <p>Emergency situations</p> Signup and view all the answers

    'The case of the missing money' was attributed to what factor?

    <p>Incorrect estimation techniques</p> Signup and view all the answers

    'Speculative demand for money' considers money as what?

    <p>An alternative to interest earning assets</p> Signup and view all the answers

    What does 'the stability of the money demand function' determine?

    <p>The reliability of empirical results in money demand equations</p> Signup and view all the answers

    What is the main focus of the money demand function?

    <p>To determine the quantity of money individuals want to hold</p> Signup and view all the answers

    What was a possible explanation for the negative results in the 1970s?

    <p>The breakdown of estimated money demand equations</p> Signup and view all the answers

    What needs to be addressed before any meaningful interpretation can be taken from empirical results in the context of money demand equation?

    <p>The issue of equation misspecification</p> Signup and view all the answers

    Study Notes

    Why Study Money Demand

    • There is a need for money to facilitate economic transactions and financial activities.
    • Studying money demand helps understand the behaviors of individuals and economies.

    Reduced Form Equation

    • A reduced form equation represents the relationship between money demand and its determinants.

    Microeconomic Determinants of Money Demand

    • Four main microeconomic determinants of money demand:
      • Income
      • Interest rate earned on alternative assets
      • Wealth (W)
      • Brokerage cost (b)

    Baumol Model

    • Used to model the transaction demand for money
    • Objective: minimize cost of managing an inventory of cash and other interest-earning assets
    • Costs: opportunity cost of holding cash and brokerage cost (b)
    • Interest elasticity of money demand: -1/b
    • Model generates a saw-tooth pattern of money holdings

    Tobin's Model

    • Used to model the speculative demand for money
    • Assumptions:
      • Return on money is riskless
      • Return on bonds is uncertain
      • Variance of the return on money is zero
    • Proportion of financial wealth held in bonds: k
    • Interest elasticity of money demand: -k/b
    • Model demonstrates the importance of diversifying wealth

    Importance of Studying Money Demand

    • Helps understand the behavior of individuals and economies
    • Allows us to analyze monetary policies and their effects on the economy
    • Understanding money demand helps central banks manage inflation and stabilize the economy

    Issues in Money Demand Analysis

    • Empirical results must be interpreted carefully due to potential issues with data and estimation methods
    • Simultaneity and endogeneity problems may arise when estimating money demand equations
    • Overly simplified econometrics may lead to misleading results

    Macroeconomic Determinants of Money Demand

    • Modeled as a function of income, interest rate, and wealth
    • Demand for money allows us to analyze the effects of monetary policies on the economy

    Other Concepts

    • 'The case of the missing money' refers to the breakdown of estimated 'demand' function in the US from 1979 to 1982
    • Interest differentials refer to the difference in interest rates between two assets
    • Precautionary money balances refer to holdings of money kept for unexpected events or expenses

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    Related Documents

    Chapter 3: The Demand for Money PDF

    Description

    Test your knowledge of Tobin’s model of portfolio selection, which involves making optimal transactions between deposit accounts and bonds with different yields and transaction costs.

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