Question

What happens to the Purchasing Power of Money, Prices and the Nominal Rate of Interest in

    CASE 1: the case of an increasing supply of money and credit?

     CASE 2: the case of a decreasing supply of money and credit?

     CASE 3: the case of an increasing demand for money and credit?

     CASE 4: the case of a decreasing demand for money and credit?

Answer 1

CASE 1 :- In the case of increasing the supply of money and credit,

PURCHASING POWER OF MONEY will fall. This is because the increase in money supply will increase the demand of goods and in order to meet the gap of the demand of goods and its supply, price will automatically rise. The rise in price of goods or say inflation reduces the value of a currency's purchasing power.

PRICES will rise i.e. inflation will take place. This is because when there is increase in supply of money or say credit, people will hold more money than they actually want and this will as a result increase their expenditure and this increase in demand by the consumers will thereafter rise the prices of the good leading to inflation.

NOMINAL RATE OF INTEREST will decrease. This is because when there is increase in supply of money it means that surplus of money will be available at the prevailing interest rate. So, in order to make the players in economy hold more money, the interest rates will fall.

CASE 2 :- In the case of decreasing supply of money and credit,

PURCHASING POWER OF MONEY will rise. This is because the decrease in money supply will lead to fall in the demand of goods and this deficient demand will lead to decrease in price of the goods. The decrease in price of goods leads to rise in the purchasing power of money.

PRICES will fall or say deflation will take place in the economy. This is because when there is decrease in supply of money or say credit, people will have less money and this will adversely affect the consumer spending i.e. consumer spending will decrease or say there will occur deficient demand which will lead to fall in prices of the goods.

NOMINAL RATE OF INTEREST will increase. This is because when there is decrease in the supply of money or say credit it means that there will be shortage of money at the prevailing interest rate. So, in order to make the players in the economy hold less money, the interest rates will rise.

CASE 3 :- In the case of increasing demand for money and credit,

PURCHASING POWER OF MONEY will decrease. This is because when there is increase in demand for money or say credit, there will increase in consumer spending or say demand of goods which will automatically leads to rise in price. This rise in price of goods will further reduce the purchasing power of money.

PRICES will rise. This is because due to increase in demand for money, people will now want to hold more money at each interest rate and which will further lead to increase in the consumer spending. This increase in consumer spending or say surplus demand of goods will lead to increase in prices of the goods.

NOMINAL INTEREST RATES will rise. This is because when there is increase in the demand of money or credit it means there is excess demand as compared to supply of credit and in order to meet this gap between demand and supply of credit or say reduce the surplus demand of money, the interest rates will increase.

CASE 4 :- In case of decreasing demand for money or credit,

PURCHASING POWER OF MONEY will increase. This is because when there is decrease in demand of money or say credit, there will be decrease in consumer spending or we can say that demand of the goods will fall. This fall in demand will further lead to fall in price of the goods. The deflation or say fall in price of the goods increasing the purchasing power of money.

PRICES will fall. This is because when there is decrease in demand of the money or say credit , people will be holding less money at each interest rate. This would further lead to decrease in consumer spending or say deficient demand . This decrease in demand would further lead to fall in prices.

NOMINAL INTEREST RATES will fall. This is because when there is decrease in demand of money or credit it means there is deficient demand or say there is surplus supply of credit as compared to demand. So, in order to meet this between gap of surplus supply of credit and the deficient demand of credit, the interest rates will fall.