(A) State whether you agree or disagree with the following statement. Explain wh

Question

(A) State whether you agree or disagree with the following statement. Explain what happens to (ii) MS and (iii) interest rates

When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.

TO ANSWER QUESTIONS

CHOOSE ONLY THREE ANSWERS FROM THE LIST BELOW

Select one or more:

(i) Agree

(i) Disagree

(ii) MS increases

(ii) MS decreases

(ii) MS unchanged

(iii) interest rate increases

(iii) interest rate decreases

(iii) interest rate unchanged

(B) State whether you agree or disagree with the following statement. Explain what happens to (ii) interest rates and (iii) MD

Inflation, a rise in the price level, causes the demand for money to decline. Because inflation causes money to be worth less households desire to hold less of it.

TO ANSWER QUESTIONS

CHOOSE ONLY THREE ANSWERS FROM THE LIST BELOW

Select one or more:

(i) Agree

(i) Disagree

(ii) interest rate increases

(ii) interest rate decreases

(ii) interest rate unchanged

(iii) MD increases

(iii) MD decreases

(iii) MD unchanged

Explanation / Answer

We disagree in the first case. It is true that money demand will increase as a result of increase in real income. Money supply is fixed by central bank and it does not change. This implies that all the increase in money demand will result in increasing the interest rate.

We disagree in the second case. Inflation reduces the value of money so the demand for money naturally Rises because now more money is needed for transactions. With increase in the price level real money balances will fall and hence interest rate will increase.

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