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The Demand for Real Money Balances and Market Equilibrium
CHAPTER 22 The Demand for Real Money Balances and Market Equilibrium
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Real Money Holdings by a Typical Household
Average holdings of real money balances over the month Time (Months) $2,100 – $1,100 – $100 – Transactions Demand Precautionary Demand
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How Households and Firms Decide What Amount of Real Balances to Hold
Benefits of Holding Real Money Balances Ability to provide a stream of services because money is available when needed to make payments, thus avoiding the need to pay a brokerage fee to get money and the inconvenience of waiting for money to arrive Interest earned on checkable deposits (for households) Cost of Holding Real Money Balances Forgone interest that nonmonetary balances would have earned versus Decision Rule Hold real money balances as long as the benefits are greater than the costs
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A Demand Curve for Real Money Balances
Interest Rate (Percent) Real Money Balances Demand
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The Demand for Real Money Balances
Interest Rate Real Money Balances Decrease in Demand D'' D D'
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Factors That Affect the Demand for Real Money Balances
An Increase in … Will Cause the Demand for Money to … Income Increase Wealth Increase Payment technologies Decrease Expected inflation Decrease Risk of other financial assets Increase Liquidity of other financial assets Decrease A Decrease in … Will Cause the Demand for Money to … Income Decrease Wealth Decrease Payment technologies Increase Expected inflation Increase Risk of other financial assets Decrease Liquidity of other financial assets Increase
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Equilibrium in the Market for Real Money Balances
Interest Rate (Percent) Real Money Balances Demand Supply A 6
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A Change in the Supply of Real Balances
Interest Rate (Percent) Real Money Balances MS MS' Increase Decrease
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Increases in the Supply of Real Money Balances
Interest Rate (Percent) Real Money Balances MS MS' Demand A B
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Expansionary Open Market Operations May Eventually Lead to Increases in Demand
Interest Rate (Percent) Real Money Balances MS MS' A C D' B D
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Other Changes Can Also Shift the Demand for Real Balances Curve
MS Interest Rate (Percent) D' D Real Money Balances
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Income = $2,000/month Price Level = 1
The Number of Broker Calls Per Month and the Average Holdings of Real Balances (Transactions Demand for Real Balances) Income = $2,000/month Price Level = 1 $2,000 $1,000 30 Days Average Daily Holding of Funds $1,000 Average Daily Holding of Funds $500 30 Days $666.67 Average Daily Holding of Funds $333.33 30 Days
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Benefits and Costs of Additional Calls to the Broker
(A) Transactions Money if Call is Not Made (B) Demand for Money if Call is Made Benefit: Interest on Additional Bonds Held Call (A) – (B) 1 2 3 4 $1,000 1,000 500 333 250 — $500 333 250 200 — $500 167 83 50 $2.50 ($500 X .005) .83 ($167 X .005) .43 ($83 X .005) .25 ($50 X .005)
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Benefits and Costs of Calls to the Broker if the Interest Rate Increases to 1 Percent Per Month
1 2 3 4 $1,000 1,000 500 333 250 — $500 200 167 83 50 $5.00 ($500 X .01) 1.67 ($167 X .01) .83 ($83 X .01) .50 ($50 X .01) Call (A) Transactions Demand for Money if Call is Not Made (B) Transactions Demand for Money if Call is Made (A) – (B) Benefit: Interest Earned on Additional Bonds Held
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