I need to consider an economy with five assets: 1) Cash 2) Checking Accounts 3)

Question

I need to consider an economy with five assets: 1) Cash 2) Checking Accounts 3) Savings and Money-Market Accounts 4) Bonds 5) Stocks. M1 includes asset classes 1 and 2, and M2 is the sum of M1 and asset class 3. All else being equal, how would each of the following changes affect demand for M1? And for M2? Explain.

(a)The stock market crashes, and investors who were previously excited about prospective gains now view it as too risky.

(b)Authorities intensify the fight against street crime, leading to more arrests and convictions for robbery. As crime rates fall, people feel safer holding cash.

(c)Banks introduce overdraft protection, under which funds are automatically transferred from savings to checking as needed to cover checks.

(d)Due to an increase in inflation expectations, the average interest rate on bonds rises from 3% to 6%.

(e)The government introduces deposit insurance, guaranteeing checking and savings deposits in the event that there are depositor runs and banks fails.

(I need to identify which asset’s attractiveness has increased (decreased) and will thus absorb more (less) funds. As agents change their portfolios, there may be several possibilities regarding where funds come from (flow to). Do not try to guess further equilibrium effects, i.e., do not worry about what would happen to prices and other behaviors that might follow if everyone in the economy did this move. Assume that these are ceteris paribus changes, i.e., other factors do not change.)

Explanation / Answer

A) Stock market crash would prompt people to go for safe things like Holding cash and checking accounts, So Demand for M1 rises

B) Demand for M1 increases, Cash is king in market with difficulties, So people look no further and go for keeping their own cash

C) Demand for M2 increases as this facility is likely to help users

D) M2 will increase, Increase in interset rates will allow more people to participate in market, They will go ahead and invest in other options

e)Demand for M2 increases phenomenally,

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