ECON 1BB3 Lecture Notes - Hot Chocolate, Classical Dichotomy, Demand Curve

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olivebuffalo693

19 Apr 2014

School

McMaster University

Department

Economics

Course

ECON 1BB3

Professor

Bridget O' Shaughnessy

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ECON 1BB3 Full Course Notes

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Document Summary

When we are drawing a demand curve for money, we use 1/p as the variable on the vertical axis, which represents the value of money. If p goes down, 1/p must be going up, and vice versa. M(d) shift out if y rises or if households decide to increase their money holdings for some other reason. M(s) vertical position determined by the central bank. Quantity theory of money: this theory suggests that the quantity of money determines the price level, the growth rate of money determines the inflation rate. Classical dichotomy: the separation of real and nominal variables, the real variable (production rate) is determined by different forces. Monetary neutrality: changes in the money supplied (ms) affect nominal variable, but not real variables. Velocity: the rate which money changes hands. Example: produce 2000 cups of hot chocolate/ week. M(money) x v(velocity) = p(price) xy(real gdp: p x y equals nominal gdp.

Related Questions

1. State whether you agree or disagree with the following statements and explain why?

a. When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.

b. Inflation, a rise in the price level, causes the demand for money to decline. Because inflation causes money to be worthless, households desire to hold less of it.

c. If the Fed buys bonds in the open market and at the same time we experience a recession, interest rates will no doubt rise.

mauvemarten239

Choose the correct answer from the brackets:

A)The demand for money is mainly influenced by three variables: r (the short-term interest rate), Y (real GDP), and P (the aggregate Price level). Suppose r rises, but Y and P are unchanged. What happens to the quantity of money demanded?

r is both the opportunity cost of holding money and the reward for holding bonds. Thus, an increase in r causes people to want to hold (more/less ) of their wealth in the form of money and ( more/less) in the form of bonds to take advantage of the higher interest rate.

Suppose real income (Y) rises while the quantity of money in the economy stays the same. What happens to money demand?

The supply of money does not automatically rise when the production of real goods and services (Y) rises. However, the collective demand for money by firms and households does rise. To get this money firms and households attempt to (buy more/ sell some of their /more /less bonds).

Thus, an increase in Y causes people to want to hold (buy more /sell some of their / more /less) of their wealth in the form of money and (buy more / sell some of their / more / less ) in the form of bonds.

C)Suppose the price level (P) rises, but Y and r are unchanged. What happens to money demand?

If Y is unchanged, people will want to buy the same amount of goods and services as before. However, since P is higher, they will need (more / less) money to do so.

Hence, an increase in P causes people to want to hold (more / less) of their wealth in the form of money and (more / less) in the form of bonds.