Question

4. (a) How would you expect each of the following to affect the demand for money for the economy? Explain.

(i) There is an increase in the competition among brokers, resulting in a lower commission charge for selling or holding of bonds or stocks.

(ii) Financial investors become more concerned about increasing riskiness of stocks.

(iii) The economy enters a boom period.

(iv) Nominal interest rate increases.

(b) For each of the scenarios described in (a), what will happen to the nominal interest rate if the Central Bank does not change the money supply? Explain your reasoning using a supply-and-demand graph of the money market.

Answer 1

Hi,

Hope You are doing well!

Question:

Answer:

Demand for money for the economy:

This is the money desire of households and businesses to hold in very liquid forms like, cash, demand deposit  rather than investments.

4. (a). Answer:

(i). Answer:

There is an increase in the competition among brokers, resulting in a lower commission charge for selling or holding of bonds or stocks. It will increase the cost of holding or transactions the securities that will increase the demand for securities (if all things remaining the same). People will prefer to investment in securities rather holding cash or other very high liquid form of money. So, it will decrease the demand for money for the economy.

(ii). Answer:

Financial investors become more concerned about increasing riskiness of stocks. Here, people are very uncertain about the stock market will prefer to hold money in very liquid forms like, cash, demand deposit  rather than investments. So, it will increase the demand for money for the economy.

(iii). Answer:

When the economy enters a boom period then its increase the growth rate of the economy and the performance of the investment securities. So, here, people will prefer to park their money in investment securities rather than to hold in very liquid forms like, cash, demand deposit . So, here the demand for money for the economy will decreased.

(iv). Answer:

when nominal interest rate increases then its increase rate of return of the investment securities. So, here, people will prefer to park their money in investment securities rather than to hold in very liquid forms like, cash, demand deposit . So, here the demand for money for the economy will decreased.

4. (b). Answer:

What will happen to the nominal interest rate if the Central Bank does not change the money supply?

An increase in the demand for money or credit will raise nominal interest rates, while a decrease in the demand for credit will decrease nominal interest rate

In the scenario of question number (i):

People will prefer to investment in securities rather holding cash or other very high liquid form of money. So, it will decrease the demand for money for the economy and increase the demand for securities for investment. Here nominal interest rate will decrease.

In the scenario of question number (ii):

Here, people are very uncertain about the stock market will prefer to hold money in very liquid forms like, cash, demand deposit  rather than investments. So, it will increased the demand for money for the economy. Here interest rate will increase because an increase in the demand for money or credit will raise nominal interest rates.

In the scenario of question number (iii):

Here, people will prefer to park their money in investment securities rather than to hold in very liquid forms like, cash, demand deposit . So, here the demand for money for the economy will decreased. So, here interest rate will decrease because a decrease in the demand for credit will decrease nominal interest rate.

In the scenario of question number (iv):

Here already nominal interest rate increase so, question is not applicable here.

Thank You