chapter9answer.doc

NSS Exploring Economics 6 Chap Ch apte terr 9

Mone Moneyy de demand mand and and mon money ey mark market et equi equili libr briu ium m

Questions p.7 !hink it o"er 1.

How much money do you keep in your purse? 2.

Why do you hold cash? 3.

If you have a large amount of unspent income, would you save the money at home or put it into a bank? Why? p.7# $iscuss 9.1 a.

Can consumption expenditure exceed disposable income? Why?

b.

Can savings exceed disposable income? Why?

p.76 !est !est yoursel% yo ursel% 9.1

Ben bought ,!!! shares of China "ife Insurance #$verseas% Company "imited at &'! per share in (anuary '!!)* He received a dividend of &!*+) per share in (une and sold the shares at &+! per share in ecember '!!)* -ssuming there are no transaction costs, what was the actual nominal rate of return in the specified period? &ig. 9.'

Is there any risk of saving money in a bank? $iscuss 9.2

What are the risks of holding money? NSS Exploring Economics 6 1uestions and -nswers to 0xercises #Chapter 2%



. /earson 0ducation -sia "imited '!

p.77 !est yoursel% 9.2

3uppose -sset - gives a higher expected rate of return than -sset B* etermine which asset is more desirable if4 a.

-sset - is a share while -sset B is a bond5

b.

-sset - is a time deposit while -sset B is a savings deposit*

9.3

6ank the following assets in descending order according to their riskiness and li7uidity, respectively* Cash

emand deposit

Bond

3hare

3aving deposit

8ime deposit

p.79 $iscuss 9.3

9oung children are consumers too but they seldom hold money* Why? p.(# $iscuss 9.4

How would the following events affect the transactions demand for money curve? a.

:any firms have engaged in vertical integration* -s a result, there are more internal transactions but fewer market transactions among firms*

b.

8he nominal interest rate decreases*

p. (7 $iscuss 9.5

How would the following events affect the asset demand for money curve? a.

ue to technological and institutional changes, income;earning assets become more li7uid*

b.

/eople expect that stock prices will rise significantly in the near future*

NSS Exploring Economics 6 1uestions and -nswers to 0xercises #Chapter 2%

'


p.9) !est yoursel% 9.4

What is the effect of a decrease in money demand on the nominal interest rate? 0xplain with the help of a diagram* 9.5

What is the effect of a decrease in money supply on the nominal interest rate? 0xplain with the help of a diagram* pp.9'*96 Exercises Multiple Choice +uestions 1.

3uppose you bought a flat for &< million at the beginning of last year* If the flat yielded an annual rent of &'!,!!! and its price rose from &< million to &+ million in the year, what was the actual rate of return on your flat last year? -*

<=

B*

+=

C*

<<=

*

<)=

2.

Which of the following assets is the least risky? -*

Hong >ong dollar savings deposits

B*

3hares

C*

Bonds

*

oreign currencies

3.

Which of the following statements about money is I@C$660C8? -*

Holding money yields no nominal income*

B*

Holding money brings no capital gain or loss in nominal terms*

C*

Holding money bears no risk*

*

:oney is the most li7uid asset*


<


4.

3uppose the nominal interest rate and the expected real interest rate are != and )=, respectively* If the actual inflation rate turns out to be A=, then the nominal rate of return and the cost of holding money are -*

!= and !=

B*

;A= and )=

C*

!= and ;A=

*

;A= and ;!=

, respectively*

5*.

/eople hold cash for transactions purposes because -*

we live in a monetary economy*

B*

money is a commonly accepted medium of exchange*

C*

money receipts and expenditures are not perfectly synchronised*

*

money is the least risky asset*

6.

8he transactions demand for money increases when -*

there is an increase in household savings*

B*

the price level rises*

C*

many companies change their wage payment method from monthly to daily*

*

the risk of holding income;earning assets increases*

7.

Which of the following statements C-@@$8 explain why people hold money rather than income;earning assets for storing wealth? -*

/eople expect that prices of income;earning assets will fall soon*

B*

/eople hold some money to minimise the risk of li7uidating assets when asset prices fall*

C*

6eturns on income;earning assets cannot cover the cost of switching assets*

*

/eople become wealthier*

8.

Which of the following factors is negatively related to asset demand for money? -*

0xpected inflation rate

B*

6isk of holding income;earning assets

C*

Cost of switching assets

*

Wealth


+


9.

8he nominal interest rate falls when there is #% an increase in money demand* #'% a decrease in money demand* #<% an increase in money supply* #+% a decrease in money supply* -*

#% or #<%

B*

#% or #+%

C*

#'% or #<%

*

#'% or #+%

10.

If the money demand increases but the money supply decreases, -*

the interest rate must rise*

B*

the interest rate must fall*

C*

the effect on the interest rate is indeterminate*

*

the interest rate increases and then decreases*

Short +uestions 1.

-re money demand, money supply and the nominal interest rate stocks or flows? 0xplain* #A marks% 2.

Compare money and gold in terms of the following aspects4 a.

@ominal returns

#' marks%

b.

"i7uidity

#' marks%

c.

6isk

#' marks%

a.

What are the transactions demand for money and asset demand for money?

#+ marks%

b.

3uggest $@0 factor which is positively related to and $@0 factor which is negatively

3.

related to them*

#+ marks%

4*.

Briefly explain why an increase in the purchase price of an asset will lead to a fall in the nominal interest rate*


#+ marks%




5.

How will the following events affect money demand andor money supply? a.

/eople expect a rise in bond prices*

#' marks%

b.

Commercial banks lend out all their excess reserves*

#' marks%

c.

/eople make more extensive use of credit cards*

#' marks%

d.

/eople expect a higher inflation rate*

#' marks%

Structured +uestions 1. a.

What is the difference between expected nominal interest rate and actual nominal interest rate?

#< marks%

b.

What is the relation between the nominal interest rate and the real interest rate? #< marks%

c.

What are the nominal and the real rates of return of holding money?

#A marks%

d.

8he cost of holding money is the real interest rate* o you agree? 0xplain*

#+ marks%

2.

/redict the change in the nominal interest rate with the help of separate diagrams in each of the following situations*

a.

ue to stock market fluctuations, income;earning assets become riskier* :oreover, the central bank raises money supply*

b.

#D marks%

8he average time interval between two successive income receipts decreases and the central bank raises money supply*

# marks%

Answers P.72 !hink it o"er

*

ree answer

'*

8o finance anticipated and unanticipated expenditures and to store wealth

<*

ree answer* 3aving money at home would mean forgoing deposit interest* 3aving money at a bank may be inconvenient as we may not be able to use the deposited money immediately*


A


P.73 Discuss 9.)

Consumption expenditure can exceed disposable income* 8he excess amount can be

a.

financed by past savings #wealth% or borrowing* 3avings cannot exceed disposable income* /eople seldom create extra savings in a bank

b.

by withdrawing other savings from another bank #total savings remain unchanged% or finance extra savings by borrowing #the interest rate on savings is generally lower than the interest rate on borrowed money%* P.76 !est ,oursel% 9.)

-ctual nominal rate of return -ctual net income receipts E

E

F

-ctual change in asset price  !!=

-mount of money invested G&!*+) F #&+! － &'!%,!!! &'!,!!!

 !!=

E !'*<= Fi 9.5

8he following are some of the risks of saving money in a bank* irstly, the nominal interest rate on bank deposits may change* 3econdly, the general price level may change and affect the real interest rate on bank deposits* 8hirdly, there is a risk of bank runs and deposit defaults* Discuss 9.

-lthough the face value of money is fixed, money is not a !!= risk;free asset* 8he risks of holding money include the following, which can cause losses to money holders* 

Inflation risk4 If the general price level increases, the real value or purchasing power of money decreases*



0xchange rate risk4 If the exchange rates of foreign currencies rise, the value of domestic currency falls as it can buy fewer foreign goods*



Bank;run risk4 If there is a bank run or a default on deposits, depositors may lose their money*



/olitical or country risk4 "egal tender issued by a government may not be accepted as the medium of exchange in the event of foreign invasion or revolution*


)


P.77 !est ,oursel% 9.

8he desirability of an asset is determined by its expected rate of return, risk and li7uidity* -lthough -sset - gives a higher expected rate of return than -sset B, -sset - #a share%

a.

is riskier than -sset B #a bond%* Which one is more desirable depends on peopleJs preference and the difference in their rates of return relative to the difference in their risks* -s a result, some people may prefer to hold shares while some may prefer to hold bonds* -lthough -sset - gives a higher expected rate of return than -sset B, -sset - #a time

b.

deposit% is less li7uid than -sset B #a savings deposit%* Which one is more desirable depends on peopleJs preference and the difference in their rates of return relative to the difference in their li7uidity* -s a result, some people may prefer to hold time deposits while some may prefer to hold savings deposits* !est ,oursel% 9.#

6iskiness of assets in descending order4



3hare, bond, time deposit, savings deposit, demand deposit, cash "i7uidity of assets in descending order4



Cash, demand deposit #cashing a che7ue involves costs%, savings deposit, time deposit, share and bond #both share and bond are transacted in a securities market% P.79 Discuss 9.#

9oung children are not independent* Whenever they want to consume, they usually need to seek the permission and support of their parents or elders* Hence, they have no need to hold money as their money expenditures and receipts #given by their parents or elders% most likely occur at the same time* P.83 Discuss 9.a.

3ince there are fewer market transactions among firms, the 7uantity of money demanded for transactions purpose drops at the same nominal interest rate* 8he :t curve shifts leftwards*

b.

3ince the :t curve shows the 7uantity of money demanded for transactions purpose at every nominal interest rate, the fall in the nominal interest rate brings no change to the :t curve but a downward movement along it*


D


P.87 Discuss 9.' a.

When income;earning assets become more li7uid, they become more desirable* Hence, the 7uantity of money demanded as an asset drops at the same nominal interest rate* 8he :a curve shifts leftwards*

b.

When people expect stock prices to rise significantly in the near future, stocks become more desirable* Hence, the 7uantity of money demanded as an asset drops at the same nominal interest rate* 8he :a curve shifts leftwards*

P.91 !est ,oursel% 9.-

- decrease in money demand shifts the :d curve leftwards* Hence, the nominal interest rate drops*


2


!est ,oursel% 9.'

- decrease in money supply shifts the :3 curve leftwards* Hence, the nominal interest rate rises*

P.95!96 Exercises Multiple Choice +uestions 1.

* 8he actual rate of return E

@et income receipts F Change in asset price  !!= /urchase price of the asset

E &'!,!!! F &,!!!,!!!  !!= &<,!!!,!!! E <)= 2.

$ption  is incorrect* 8he money values of foreign currencies in H> fluctuate with their exchange rates*

3.

-lthough the face value of money is fixed, money is not a !!= risk;free asset* Its real value #purchasing power% may fluctuate as the general price level or the exchange rate changes* efaults of deposit money or legal tender may occur if there is a bank run, foreign invasion or revolution*

4.

8he nominal rate of return on money is != and the cost of holding money is the nominal interest rate #!=%*


!


5.

$ption C is correct* If money receipts and expenditures are perfectly synchronised, there is no need for people to hold cash for transactions purposes* $ption  is incorrect* 8hat money is the least risky asset is the reason for asset demand for money, not transactions demand*

6.

$ptions - and C are incorrect* 8hey reduce the transactions demand for money* $ption  is incorrect* 8his raises the asset demand for money instead of the transactions demand*

7.

When people become wealthier, people hold more money as well as more income; earning assets*

8.

$ption - is correct* - rise in the expected inflation rate would raise the nominal interest rate and reduce the asset demand for money* $ptions B, C and  are incorrect* 8hey are positively related to the asset demand for money*

9.

C

10. P. 96 Short +uestions 1.

:oney demand is a stock as it measures the total 7uantity of money that all economic agents of an economy desire to hold at a certain moment* 8he addition of a period is meaningless* or example, saying that money demand in (an '!! was &!! billion per year is pointless* #' marks% :oney supply is also a stock as it measures the 7uantity of money available in an economy at a certain moment* 8he addition of a period is meaningless* or example, saying that money supply in (an '!! was &!! billion per year is pointless* #' marks% @ominal interest rate is a flow as it measures the rate of return of holding an asset in a period of time* 8he specification of the period concerned is necessary because periods of different lengths imply a different magnitude* or example, a nominal interest rate of <= a month is larger than a nominal interest rate of <= a year* #' marks%

2.

a. :oney has Kero nominal return while gold has a nominal return e7ual to the

change in its price, which can be positive or negative* #' marks% b. :oney is more li7uid than gold* :oney is already a medium of exchange but

gold has to be sold in the market to become a medium of exchange* #' marks% c. :oney is less risky than gold as the expected and the actual nominal returns of

money are certain to be Kero, but the expected and actual nominal returns of gold may not be e7ual as its market value may fluctuate unexpectedly* #' marks%





3.

a. 8ransactions demand for money is the total amount of money that an economy

desires to hold as a medium of exchange in conducting transactions* -sset demand for money is the total amount of money that an economy desires to hold as an asset to store wealth* #+ marks% b. actors positively related to :t include real national income, the price level and time

interval between two successive income receipts* actors negatively related to :t include savings and technological factors* actors positively related to :a include the risk of holding income;earning assets, the cost of switching assets and wealth* actors negatively related to :a include the nominal interest rate, expected real interest rate and expected inflation rate* #:ark the first factor suggested*  mark each*% 4.

@ominal interest rate or nominal rate of return on an asset E

@et income receipts F Change in asset price  !!= # mark% /rincipal or purchase price of the asset

When the purchase price rises, net income receipts remain unchanged but the value of Lchange in asset priceJ drops #elaborated in the note below% and hence the value of the numerator falls* $n the other hand, the value of the denominator rises* Hence, the nominal interest rate declines* #< marks% @ote4 3uppose the asset price was originally expected to rise from &D! #at present% to &'! #in future%* 8he capital gain is &+! #E &'! M &D!%* If the purchase price #at present% rises from &D! to &!!, based on the same expectation, the capital gain is &'! #E &'! M &!!%* 8he return on the asset drops* If the asset price was originally expected to fall from &D! #at present% to &+! #in future%, the capital loss is &+! #E &+! M &D!%* If the purchase price #at present% rises from &D! to &!!, based on the same expectation, the capital loss is &A! #E &+! M &!!%* 8he return on the asset drops*


'


5.

a. When people expect a rise in bond prices, people prefer to sell their bonds later or

hold more bonds to earn a higher return* 8hen, the asset demand for money falls* #' marks% b. When commercial banks lend out all their excess reserves, more loans are created*

:oney supply increases* #' marks% c. When people use credit cards more extensively, people can hold less money to

conduct transactions* 8ransactions demand for money drops* #' marks% d. When people expect a higher inflation rate, the nominal interest rate

GE real interest rate F #expected% inflation rate rises and the cost of holding money increases* Conse7uently, the asset demand for money declines* #' marks% Structured +uestions 1. a.

8he expected nominal interest rate is the estimated one because the future event has not occurred or people do not have information about it* 8he actual nominal interest rate is the realised one because the past event has occurred and people have information about it* 8herefore, the expected rate may not be e7ual to the actual rate* #< marks%

b.

@ominal interest rate E 6eal interest rate F Inflation rate* When there is inflation #deflation%, the nominal interest rate is larger #smaller% than the real interest rate* #< marks%

c.

3ince money does not bear interest and the face value of money does not change, the nominal rate of return of holding money is Kero* #< marks% 6eal rate of return E @ominal rate of return M Inflation rate 3ince the nominal rate of return on money is Kero, the real rate of return on money E ! M Inflation rate E ;Inflation rate #< marks%

d.

When people hold money, one cannot hold the income;earning asset which yields the #highest% nominal interest rate* Hence, the cost of holding money is the #highest% nominal interest rate #forgone%* 8he statement is wrong* #< marks% 3ince the nominal interest rate is e7ual to the real interest rate plus the inflation rate, the cost of holding money may be e7ual to the real interest rate only when the inflation rate is e7ual to Kero* # mark%


<


2. a.

When income;earning assets become riskier, the asset demand for money increases* 8he money demand curve shifts rightwards* # mark% When the central bank increases the money supply, the money supply curve shifts rightwards* # mark% -s a result, the change in the nominal interest rate is uncertain, depending on the extent of the shift in both curves* If the increase in money demand is larger than #e7ual to  smaller than% the increase in the money supply, the nominal interest rate increases #remains unchanged  decreases%* #< marks%

#0ach case,  mark*% #< marks%


+


b.

When the average time interval between two successive income receipts decreases, the transaction demand for money drops* 8he money demand curve shifts leftwards* # mark% When the central bank raises money supply, the money supply curve shifts rightwards* # mark% -s a result, the nominal interest rate must drop* # mark%

#' marks%





chapter9answer.doc

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