Explain how the following events will affect the demand for money according to t

Question

Explain how the following events will affect the demand for money according to the portfolio theories of money demand:

The economy experiences a business cycle contraction.

A.The demand for money decreases during recessions.

B.The demand for money increases during recessions.

C.The demand for money does not change.

D.There is not enough information provided to determine the effect on money demand.

Brokerage fees rise, making bond transactions more expensive.

A.The demand for money does not change.

B.The demand for money decreases.

C.The demand for money increases.

D.There is not enough information provided to determine the effect on money demand.

The stock market crashes.

(Hint: Consider both the increase in stock price volatility following a market crash and the decrease in wealth of stockholders.)

A.The demand for money decreases.

B.The demand for money increases.

C.The demand for money does not change.

D.There is not enough information provided to determine the effect on money demand.

Explanation / Answer

When economy experiences a business cycle contraction, interesr rates are expected to fall. Also, business cycle contraction increases the risk associated with other assets thereby decreasing the liquidity of other assets. Both these happenings leads to decrease in demand for money as making new investments becomes less profitable.

Hence, the correct answer is option (A).

When brokerage fee rises, cost of undertaking a transaction such as investment in bonds become expensive. This induce the people to hold larger cash blalances and avoid making frequent investments and withdrawals leading to increase in demand for money.

Hence, the correct answer is option (C).

Crash in stock market considerably reduce the wealth of stockholders and price movement after stock market crash also tends to be highly volatile. This refrains the investor from putting their money in stock market and thus their demand for money decreases.

Hence, the correct answer is option (A).

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