18 Questions
What is the total demand for money, denoted as L, equal to?
La + Lp
Which motive for holding money leads to the demand for active money balances?
Precautionary and transactionary motives
According to the liquidity preference theory, what factors does the demand for real money balances depend on?
Level of income and interest rate
Which type of money demand derives from carrying out normal predictable transactions?
Transactionary demand
What does passive money balances represent in the context of money demand?
Demand for speculative purposes
Which element is not considered when defining money in real terms?
Interest rates
What is the role of the P800 in the banking system described in the text?
Serve as demand deposits in Second Bank
What does Second Bank retain as reserves?
20%
In the scenario presented, what does the P640 ultimately become in the banking system?
Demand deposits in Third Bank
What formula is used to calculate the total increase in money supply from an initial change in reserves?
$∆𝑀 = ∆𝑅 - 𝑟$
Based on the given example, if the reserve requirement ratio is 15%, what would be the change in money supply if the initial change in reserves is P3000?
$P15000$
What does the equation 𝑀 = 𝐶𝑈 + 𝐷 represent from the text?
Determination of money stock
What type of banking system does the text describe in the scenario where a bank is required to maintain 100% of its liabilities as reserves?
Fractional reserve banking
Under 100% reserve banking, how does the banking system affect the money supply?
Has no impact on the money supply
In a fractional reserve banking system, what percentage of deposits must a bank hold as reserves based on the text provided?
20%
After making a loan with 80% of the deposit in a fractional reserve banking system, what is the new total money supply according to the text?
$1,800
In a fractional reserve banking system, what is one of the functions that banks are said to perform?
Create money through loans
Which term describes the scenario where an individual still has demand deposits but also holds currency after a loan is made in a fractional reserve system?
Liquidity preference
Study Notes
Money Demand
- Economic agents are only interested in the value of money in terms of its purchasing power.
- Money is defined in real terms as nominal money demand divided by the price level.
Liquidity Preference Theory
- The demand for real money balances depends on the level of income (Y) and the interest rate (i).
- The total demand for real money balances is the sum of demand for active money balances (La) and demand for passive balances (Lp).
Demand for Active Balances (La)
- Transactions demand for money arises from the use of money in carrying out normal transactions.
- Precautionary money demand is to cater for unforeseen contingencies.
Money Creation
- The banking system creates money through the process of deposits and loans.
- The total increase in money supply is given by: ∆M = ∆R / r, where ∆R is the initial change in reserves, ∆M is the change in money supply, and r is the reserve requirement ratio.
Money Stock Determination
- The money stock is determined by the behavior of the public (currency-deposit ratio) and commercial banks (reserve-deposit ratio).
- The money stock equation is: M = CU + D, where M is the money stock, CU is currency held by the public, and D is deposits.
Reserve Requirements
- Under 100% reserve banking, the banking system does not affect the supply of money.
- Under fractional reserve banking, banks create money by loaning out a portion of their deposits.
Banking System
- A deposit into a bank increases the bank's liabilities and assets.
- The bank retains a portion of the deposit as reserves and loans out the rest, creating new money.
Learn about the concept of money demand in real terms, where money is defined based on its purchasing power rather than nominal holdings. Explore the Liquidity Preference Theory which analyzes how individuals and businesses make decisions regarding the amount of money to hold.
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