Question 1

1. The opportunity cost of holding money Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the $5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond. The opportunity cost of holding the inheritance as money depends on the interest rate on the bond. For each of the interest rates in the following table, compute the opportunity cost of holding the 5,000 as money. Interest Rate on Government Bond Opportunity Cost (Percent) (Dollars per year) 9 v 11 v What does the previous analysis suggest about the market for money? O The quantity of money demanded increases as the interest rate rises. The quantity of money demanded decreases as the interest rate rises. O O The supply of money is independent of the interest rate. Grade It Now Save & Continue M amdima s ar R ] 2. The theory of liquidity preference and the downward-sloping aggregate demand curve Suppose the money market for some hypothetical economy is given by the following graph, which plots the money demand and money supply curves. Assume the central bank in this economy (the Fed) fixes the quantity of money supplied. Suppose the price level increases from 90 to 105. Shift the appropriate curve on the graph to show the impact of an increase in the overall price level on the market for money. 12 Money Supply O 10 Money Demand Money Supply INTEREST RATE (Percent) Money Demand N 0 20 60 80 100 120 MONEY (Billions of dollars) Following the price level increase, the quantity of money demanded at the initial interest rate of 6% will be than the quantity of money supplied by the Fed at this interest rate. As a result, individuals will attempt to their money holdings. In order to do so, they will bonds and other interest-bearing assets, and bond issuers will realize that they interest rates until equilibrium is restored in the money market at an interest rate of %The following graph plots the aggregate demand curve for this economy. Show the impact of the increase in the price level by moving the point along the curve or shifting the curve. 180 O 150 Aggregate Demand 120 PRICE LEVEL Aggregate Demand 30 0 40 80 120 180 200 240 OUTPUT (Billions of dollars) The change in the interest rate found in the previous task will lead to a _ in residential and business spending, which will cause in the quantity of output demanded in the economy. Grade It Now Save & Continue