Question

5. This problem examines the effect of the introduction of ATMs and credit cards on money demand. For simplicity, let's examine a person's demand for money over a period of four days. Suppose that before ATMs and credit cards, this person goes to the bank once at the beginning of each four-day period and withdraws from her savings account all the money she needs for four days. Assume that she needs $20 per day. a. How much does this person withdraw every time she goes to the bank? Compute the person's money holdings for days 1 through 4 (in the morning before she spends any of the money she withdraws.) b. What is the amount of money this person holds per day on average? Suppose now that with the advent of ATMs this person withdraws money once every two days. c. Recalculate your answer to part a. d. Recalculate your answer to part b. Finally, with the advent of credit cards, this person pays for all her purchases using her card. She withdraws no money until the fourth day, when she withdraws the whole amount necessary to pay for her credit card purchases over the previous four days. e. Recalculate your answer to part a. f. Recalculate your answer to part b. & Based on your previous answers, what do you think has been the effect of ATMs and credit cards on money demand?

Answer 1

Part A

$80 withdrawn each trip to the bank. That is,

Money holding are $80 in day one, $60 on day two, $40 on day three and $20 on day four.

Part B

Average money holdings are,

$=\frac{80+60+40+20}{4}=\$50$

Part C

$40 withdrawn each trip to the bank.

Money holdings are $40, $20, $40, $20 on day one, two, three and four respectively.

Part D

Average money holdings are,

$=\frac{40+20+40+20}{4}=\$30$

Part E

$80 on each trip to the bank

Money holdings are,

$0,$0,$0,$40 in day one, two, three and four respectively.

Part F

Average holdings are,

$=\frac{40}{4}=\$10$

Part G

Based on the above answers, it assumed that ATM and credit cards have reduced money demand.