Asset, price and Money Market

 2. What are the three functions of money? How does each function contribute to a more smoothly operating economy?

    The three main purpose of money are:

It is a medium of exchange, that contributes to a better-functioning economy by allowing people to make trades at a lower cost in time and effort than in a barter economy.

As a unit of account, which provides a single, uniform measure of value.

The store of value, by which money is a way of holding wealth that has high liquidity and little risk.

4. What are the four characteristics of assets that are most important to holders of wealth? How does money compare with other assets for each characteristic?

The 4 main purposes of assets that are most important to wealth holders are, the, risk, the expected return, liquidity; and time to maturity. The low expected return of money (compared to other assets) however it has a low risk. This is because it has the lowest time of maturity,which is 0, and it always maintains its nominal value.

6. List and discuss the macroeconomic variables that affect the aggregate demand for money.

The macroeconomic variables that have the greatest effects on money demand are the price level, real income, and interest rates. Higher prices or incomes increase people’s need for liquidity and thus raise the demand for money. Interest rates affect money demand through the expected return channel: The higher the interest rate on money, the more money people will demand; however, the higher the interest rate paid on alternative assets to money, the more people will want to switch from money to those alternative assets.

7. Define velocity. Discuss the role of velocity in the quantity theory of money.

Velocity is an evaluation of how often money “turns over” in a certain time.

Velocity = Nominal GDP / Nominal money supply.

The quantity theory of money assumes that velocity is always constant, which means that real money demand is proportional to real income and is unaltered by the real interest rate.

9. What is the relationship between the price level and the nominal money supply? What is the relationship between inflation and the growth rate of the nominal money supply?

The price level is proportional to the nominal money supply; in particular it equals the nominal money supply divided by real money demand when this happens this is called the equilibrium point, the inflation rate is equivalent to the growth rate of the nominal money supply subtracting the growth rate of real money demand.

10. Give an example of a factor that would increase the public’s expected rate of inflation. All else being equal, how would this increase in the expected inflation rate affect interest rates?

Increases in money growth or turns down in income growth are situations that may raise the public’s expected rate of inflation. This also happens when there is no effect on the real interest rate, the raise in the expected inflation rate would boost the nominal intere

 Analytical Problems

3-) The prisoner-of-war camp described by Radford periodically received large shipments of cigarettes from the Red Cross or other sources.

a. How did cigarette shipments affect the price level (price of goods in terms of cigarettes) in the POW camp?

Since in this case cigarettes = money, as the money supply increased and there was more liquidity in the camp, an increase in the price level would occur. This means that as people in the camp gets more cigarettes, inflation gets into the picture and the value of each cigarette would decrease.

b. on some occasions the prisoners knew in advance when the cigarettes shipments were t arrive. What happened to the demand for cigarette money and the price level in the camp in the day just before an anticipated shipment?

The demand for cigarettes would fall, but the demand for other goods would increase since people would expect the price levels to rise, since they expect higher future prices they will demand more now, making prices to increase before the shipment arrives.

4. Assume that prices and wages adjust rapidly so that the markets for labor, goods, and assets are always in equilibrium. What are the effects of each of the following on output, the real interest rate, and the current price level?

a. A temporary increase in government purchases :

A temporary increase in government purchases would decrease savings, which would lead to the government implementing higher taxes in other to math prices and wages.

This would lead for output to stay the same, Real Interest to increase and current price level to increase as well.

b. A reduction in expected inflation.

 A reduction in expected inflation would lead to an increase in real money demand because people do not expect inflation to increase for a while. Therefore more demand creates a decrease in the price level. Everything else stays the same. This would lead for output to stay the same, Real Interest to stay the same and current price level to decrease.

A temporary increase in labor supply.

A temporary increase in labor supply would mean more people have jobs and therefore more people can save. If more people save the interest rates are prone to decrease therefore money demand will increase. . This would lead for output to increase, Real Interest to decline and current price level to decrease.

An increase in the interest rate paid on money.: .

An increase in the interest rate paid on money will cause a higher demand of money. With the same nominal money supply and a higher demand of money the price would decline but everything else stays constant. This would lead for output stay the same, Real Interest to stay the same and current price level to decrease.