Intermediate Macroeconomics Sample Problems

9. Money Demand


1. Transactions Motive
2. Precautionary Motive
3. Speculative Motive
4. Empirical Results

1. Transactions Motive

1. According to the Transactions theory of money demand, the money demand should increase as

a. the nominal interest rate increases.
b. the level of income declines.
c. the cost of money transactions (e.g., buying or selling interest-bearing assets) increases.

Answer: C. Answers (A) and (B) could have been correct if the direction of change had been rveresed. Given the proliferation of direct deposit, on-line banking, credit cards, ATMs, the costs of transferring money between cash and interest-bearing accounts appear to have declined. This implies a reduction in money demand and an increase in the velocity of money (from the quantity theory of money in the previous chapter).

2. Precautionary Motive

1. The precautionary demand for money will increase with

a. greater uncertainty about future events
b. lower interest rates
c. consequences for being unable to pay bills (illiquidity) become more severe
d. decrease in anticipated cash flow, increasing the probability of illiquidity

Answer: All answers are correct. Here the influences on money demand are slightly different from the transactions motive. While the effect of interest rate is consistent, we now must deal with uncertainty about the future. Under the transactions demand a recession,which leads to a decline in income, reduces money demand. With the precautionary motive a recession, which leads to an increase in uncertainty about future income and expenses, may increase money demand.

File last modified: October 1, 2004

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