ECON 2105 1nd Edition Final Exam Study Guide Lectures: 22 - 26Module 28I. Demand for Money - Opportunity cost of holding money?o There is a price to be paid for the convenience of holding money. o We all carry some cash around for the convenience. When we do, we give up interest income we’d collect if that spending power were in an interest-bearing asset like a bond o The higher the interest rate, the higher the opportunity cost of holding moneyo People lower money demand when there are high interest rates - What happens to the opportunity cost of holding cash if…o Merchants charge 1% fee on debit/credit card transactions for purchases of less than $50?  say interest rate is 5%, opportunity cost will go down 1% so opportunity cost will be 4%o Banks raise the interest paid on saving accounts?  opportunity cost is higher when interest rates rise o Real estate prices fall significantly?  opportunity cost of holding cash, not much impact because 2 markets are not strongly correlated o What happens to the opportunity cost of holding money if the banks start offering interests on checking account holdings?  rate on savings is 4% and rate on checking is 5%, opportunity cost of holding money 4%-1%= 3% so it goes down. - A trade-off - Hold cash get zero nominal interest- Hold non-monetary asset, earn some interest- Selected interes rates of 2007 -- real return on holding cash is always negative - As a rule, most short-term rates tend to move in the same direction.- We assume that there is just one interest rate in the economy in the shortrun. We use r to represent that short term interest rate.- Short-term interest rates: the interest rates on financial assets that mature within six months or less.- Long-term interest rates: interest rates on financial assets that mature a number of years in the future.- Question: What is the correlation between interest rate and the money demand?II. Money Demand Curve - The money demand curve shows the relationship between the quantity of money demanded and the interest rate.- At higher interest rates, the cost of holding money is ________, so less quantity is demanded (countries like Venezuela with r=17 %)- At lower interest rates, the cost of holding money is ______, so a higher quantity is demanded (countries like Japan with r=0 %)- Keeping all other things constant, o changes in aggregate price level Higher prices mean we need more _money_____ for transactions (and vice versa).o changes in real GDP (changes in income) The more money peoplemake (the higher the real GDP), the __more ___ they purchase (and vice versa).o changes in technology The ease of credit card payments ___lower____ the need for cash.o changes in institutions After 1980 banks were allowed to offer interest on checking accounts. This decreased the cost of holding money, and money demand ___________.- A fall in money demand shifts the money demand curve to the left.- A rise in money demand shifts the money demand curve to the right.- What happens to demand curve if o Short term interest rates rise from 5% to 30%? no change o All prices fall by 10%?  shift to the left o New wireless technology automatically charges the supermarket purchases to credit cards, eliminating the need to stop at the cash register?  shift to the left o In order to avoid paying taxes, a vast underground economy develops in which workers are paid their wages in cash rather than with checks?  - The higher the interest rate, the higher the opportunity cost of holding money.- The lower the interest rate, the lower the opportunity cost of holding money.- But, what determines the interest rate?o The money market - We need to understand how interest rates are determined in the market.- The liquidity preference model of the interest rate asserts that the interest rate is determined by the supply and demand for money in the money market.- In the money market, we have o Money demando Money supply o Interest rate (price of the money)- Price of an asset and the return on an assets are negatively correlated. - Think of a $100 worth of T-bills (matures in a year) with a 2% coupon offerings:o If the price of the T-bills now is $100, the nominal return on the asset is 2%.o If the price of the T-bills now is $90, the nominal return on the asset is higher than 2%.o If the price of the T-bills now is $110, the nominal return on the asset is less than 2%.- At rH, interest rates are high. MS > MD, and a surplus of money means there is a shortage of other assets like bonds. - At rL , interest rates are low. MD > MS, and a shortage of money means there is a surplus of other assets like bonds. Module 29I. Saving - Three major savers in the nationo The private sectoro The public sectoro The foreign savers- overseas want to put some savings in the US - Budget Balance: (the govt) government revenues minus government spending o Revenues include: taxes (income or on corporations), tariffs on foreignerso Spnding- on goods and services, defense, education, unemployment, medicare, social security o Net saver or net spender o If negative  we are in budget deficit - Net Capital inflow (NCI): amount of money coming from overseas, capital inflow- capital outflow o Capital inflow  they buy our bonds, they buy our stocks, we sell them things o capital outflow: Investments French stock we buy, German bondwe buy o if NCI is positive we are net borrowers (we have been like this since 1981, bc us consumption is higher than our production)o if NCI is negative we are net lenders- investment Spending – spending on physical capital o Buying stocks, bonds, or gold is NOT considered as investment spending (it can be called as “making an investment”, the act of purchasing an asset)o When macroeconomists use the term investment spending, they almost always mean spending on new physical capital.o Only spending that adds to the economy’s stock of physical capital is investment spending. - In the US investment spending > national spending (public an private) + private spending o Savings= private savings + public savings o Private= real gdp + transfer payments – taxes – consumption o Public= revenues- expenses - The Market for Loanable Funds o The loanable funds market is a __hypothetical___ market that examines the market outcome of the demand for funds generatedby __borrowers (entrepreneurs)__ and the supply of funds provided by