Exam 11: Money Demand and the Equilibrium Interest Rate

Suppose there is an excess demand for money. Explain what will happen in the money market as a result of this.

By the middle of 2008 the Fed had driven the short-term interest rate close to zero, and it remained at essentially zero through the middle of 2010. How do you think this affected people's decision of whether to hold on to money or hold bonds instead?

-Using the graph above, answer the following questions. a. Which interest rate would result in an excess demand for money? What would eventually happen to the interest rate? b. Which interest rate would result in an excess supply for money? What would eventually happen to the interest rate?

Assume the money market is initially in equilibrium. Now, suppose the Fed sells bonds. Graphically illustrate and explain what effect this Fed open-market sale of bonds will have on the money market.

In simple terms how is the interest rate determined in the economy and explain why?

Assume that the interest rate paid on bonds rises from 4% to 6%. Explain what would happen to the level of optimal (money) balances.

Draw a graph illustrating the idea behind the non-synchronization of income and spending.

Draw a demand curve for money. Explain the two factors that could cause an increase in the demand for money.

Why are money demand and saving not really the same thing for the household?

What do economists mean when they say that there is an "excess supply of money" in the economy? Illustrate this situation graphically. If there is an excess supply of money, what happens to the interest rate? How does the change in the interest rate influence the trade-off between holding money and holding bonds?

Explain what demands make up the total demand for money.

Explain how people will switch between bonds and money if the interest rate is initially below the market-clearing level. Explain your answer in terms of opportunity costs.

What is the prime rate?

Define what economists mean by the term interest rate.

Assume that the current interest rate is 9% . Assume that investors know that normally interest rates are 7%. How would this affect investors' decisions with regard to how much money and bold holdings to keep?

Show on a graph what the effect on the demand for money would be after an increase in income.

Assume the money market is initially in equilibrium. Now suppose there is an increase in income. Explain what effect this increase in income will have on the equilibrium interest rate. Also explain what the Fed would have to do if it wants to prevent this change in Y from affecting the interest rate.

Explain briefly what the optimal balance of money strategy is.

Explain the trade-off between holding bonds and holding money. Why don't people keep all their assets in the forms that are the easiest to use for making transactions?

What is meant by the nonsynchronization of income and spending?