Answer to Question #252030 in Macroeconomics for Paul Hackman

Question

1.Using examples, explain the three motives of people's demand for money.

2. Illustrate a downward shift in the IS curve . Describe three factors that could shift the IS curve.

3) a. What is the money multiplier ?

b. How do we derive the money multiplier?

c. What is the magnitude in money multiplier ?

d. What account for this magnitude?

Answer 1

Solution:

1.). The desire to hold financial assets in the form of money is referred to as the demand for money. The three motives of people’s demand for money are as follows:

i.).  The transactions motive - The transaction motive for requiring money stems from the fact that the majority of transactions involve the exchange of money. Money will be demanded because it is necessary to have money available for transactions. For example, when you want to purchase assorted items, you will demand money so that you can perform multiple transactions.

ii.). The precautionary motive - People frequently demand money as a form of insurance against an uncertain future. Unexpected expenses, such as medical bills or car repair bills, frequently necessitate immediate payment. The precautionary motive for demanding money refers to the need to have money available in such situations.

 

iii.). The speculative motive - Money, like other forms of value, is an asset. The demand for an asset is determined by its rate of return as well as its opportunity cost. Money holdings typically provide no rate of return and frequently depreciate in value due to inflation. The interest rate that can be earned by lending or investing one's money holdings is referred to as the opportunity cost of holding money. The speculative motive for demanding money arises when holding money is perceived to be less risky than lending the money or investing it in another asset. For example, if a stock market crash appeared to be imminent, the speculative motive for demanding money would come into play; those anticipating a crash would sell their stocks and keep the proceeds as money.

2.). An illustration of a downward shift in the IS curve is as follows:

 

 

When an autonomous change occurs in C, I, G, T, or NX, the IS curve shifts. When C, I, G, or NX rises, IS curve shifts to the right and when C, I, G, or NX falls, the IS curve shifts to the left. When T rises (falls), all else remains constant, the IS curve shifts left (right) because taxes effectively reduce consumption. Also, changes in people’s income levels can result in a shift in the IS curve.

 

3.a.). The Money Multiplier describes how a small initial deposit can lead to a larger overall increase in the money supply.

 

b.). The money multiplier is derived from the reciprocal of the reserve ratio minus one.

 

c.). The magnitude of the money multiplier refers to how an initial deposit can lead to a bigger final increase in the total money supply.

 

d.). The magnitude of the money multiplier is determined by the value of the marginal propensity to consume (MPC), which refers to the proportion of an increase in income that gets spent on consumption.