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Questions and Answers
Explain how money serves as a unit of account in an economy.
Explain how money serves as a unit of account in an economy.
Money provides a common standard for measuring the relative value of goods, services, and resources.
Differentiate between commodity money and fiat money, providing an example of each.
Differentiate between commodity money and fiat money, providing an example of each.
Commodity money has intrinsic value (e.g., gold coins), while fiat money has value because the government declares it as legal tender (e.g., paper currency).
Describe how inflation affects the functions of money, particularly as a store of value.
Describe how inflation affects the functions of money, particularly as a store of value.
High inflation erodes money's purchasing power, making it a less reliable store of value. People may prefer to hold other assets that maintain or increase their value during inflation.
Explain the concept of liquidity preference and how it influences the demand for money.
Explain the concept of liquidity preference and how it influences the demand for money.
How does an increase in real GDP typically affect the transaction demand for money?
How does an increase in real GDP typically affect the transaction demand for money?
According to the quantity theory of money, what is the primary determinant of inflation?
According to the quantity theory of money, what is the primary determinant of inflation?
Explain the role of interest rates in influencing the speculative demand for money.
Explain the role of interest rates in influencing the speculative demand for money.
Describe how the precautionary motive influences an individual's decision to hold money.
Describe how the precautionary motive influences an individual's decision to hold money.
According to the Cambridge approach, what factors, besides the volume of transactions, influence the demand for money?
According to the Cambridge approach, what factors, besides the volume of transactions, influence the demand for money?
Contrast the Fisher equation with the Cambridge equation in their approaches to the demand for money.
Contrast the Fisher equation with the Cambridge equation in their approaches to the demand for money.
If the money supply increases by 8% and real GDP increases by 3%, what is the expected rate of inflation according to the quantity theory of money (assuming constant velocity)?
If the money supply increases by 8% and real GDP increases by 3%, what is the expected rate of inflation according to the quantity theory of money (assuming constant velocity)?
Explain how technological advancements (e.g., mobile banking) can impact the demand for money.
Explain how technological advancements (e.g., mobile banking) can impact the demand for money.
How do expectations about future economic conditions influence the demand for money?
How do expectations about future economic conditions influence the demand for money?
What is the relationship between the demand for money and the level of price volatility in an economy?
What is the relationship between the demand for money and the level of price volatility in an economy?
Describe the potential effects of a deflationary environment on the demand for money.
Describe the potential effects of a deflationary environment on the demand for money.
Explain how government policies, such as quantitative easing, can influence the money supply and, consequently, inflation.
Explain how government policies, such as quantitative easing, can influence the money supply and, consequently, inflation.
How does the Fisher effect relate nominal interest rates to inflation expectations?
How does the Fisher effect relate nominal interest rates to inflation expectations?
What are the key assumptions underlying the classical dichotomy, and how do they influence the relationship between the money supply and real economic variables?
What are the key assumptions underlying the classical dichotomy, and how do they influence the relationship between the money supply and real economic variables?
Discuss the implications of sticky prices and wages for the effectiveness of monetary policy in influencing real output in the short run.
Discuss the implications of sticky prices and wages for the effectiveness of monetary policy in influencing real output in the short run.
In a situation of near-zero interest rates, how might a central bank attempt to stimulate aggregate demand, and what are the potential challenges?
In a situation of near-zero interest rates, how might a central bank attempt to stimulate aggregate demand, and what are the potential challenges?
Flashcards
What is Money?
What is Money?
Anything generally accepted as a medium of exchange, a store of value, and a unit of account.
What is Currency?
What is Currency?
A physical form of currency like coins and banknotes.
What is Money Supply M1?
What is Money Supply M1?
Includes currency plus balances in checking accounts.
What is Money Supply M2?
What is Money Supply M2?
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What are the Functions of Money?
What are the Functions of Money?
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What is Money Demand?
What is Money Demand?
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What is the Quantity Theory of Money?
What is the Quantity Theory of Money?
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Study Notes
- Money is anything that is generally accepted as a medium of exchange, a store of value, and a unit of account
Types of Money
- Commodity money has intrinsic value, like gold or silver
- Fiat money is declared by a government to be legal tender, and has no intrinsic value
Functions of Money
- Medium of exchange: Facilitates transactions, reducing the need for barter
- Store of value: Allows individuals to transfer purchasing power to the future
- Unit of account: Provides a common standard for measuring economic value
Demand for Money
- Transaction demand: Money is needed to facilitate day-to-day transactions
- Precautionary demand: Money is held as a buffer against unforeseen circumstances
- Speculative demand: Money is held to take advantage of future changes in interest rates or asset prices
Classical Theory of Money
- Quantity theory of money: Changes in the money supply lead to proportional changes in the price level
- Assumes that velocity of money is constant
- Focuses on the long-run relationship between money and prices
Fisher's Equation of Exchange
- MV = PQ, where:
- M = Money supply
- V = Velocity of money
- P = Price level
- Q = Quantity of output
- Velocity of money (V) is the rate at which money changes hands in the economy
- Classical economists believed V was stable and determined by institutional factors
- Q (Quantity of output) is assumed to be at full employment level in the classical model
- Increase in M leads to a proportional increase in P
Cambridge Approach
- Focuses on money demand rather than money supply
- Emphasizes the store of value function of money
- Md = kPQ, where:
- Md = Demand for money
- k = Proportion of income people want to hold as cash balances
- P = Price level
- Q = Quantity of output
- The Cambridge approach implies that money demand is proportional to nominal income (PQ)
- k is determined by factors like payment habits and the cost of holding money
- Assumes stable money demand
- Changes in money supply affect the price level
Differences between Fisher and Cambridge Approaches
- Fisher focuses on the mechanism (transactions), Cambridge on the motivation (holding money)
- Fisher emphasizes velocity, Cambridge emphasizes the proportion of income held as money (k)
- Both approaches lead to the same basic conclusion: money supply influences the price level
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