ch11 Money Demand and the Equilibrium Interest Rate.pptVIP

Prepared by: Fernando Quijano Shelly Tefft;;Interest Rates and Bond Prices;In Chekhov’s play Uncle Vanya, Alexander Vladimirovitch Serebryakov, a retired professor, but apparently not of economics, calls his household together to propose the following: …Our estate yields on an average not more than two per cent, on its capital value. I propose to sell it. If we invest the money in suitable securities, we should get from four to five per cent, and I think we might even have a few thousand roubles to spare… Uncle Vanya tried to kill Professor Serebryakov for this idea, but no one pointed out that this was bad economics and not a scheme. Perhaps had Uncle Vanya taken an introductory economics course and known this, he would have been less agitated.;transaction motive The main reason that people hold money—to buy things. ;Income arrives only once a month, but spending takes place continuously. ;Jim could decide to deposit his entire paycheck ($1,200) into his checking account at the start of the month and run his balance down to zero by the end of the month. In this case, his average balance would be $600. ;Jim could also choose to put half of his paycheck into his checking account and buy a bond with the other half of his income. At midmonth, Jim would sell the bond and deposit the $600 into his checking account to pay the second half of the month’s bills. Following this strategy, Jim’s average money holdings would be $300. ;The quantity of money demanded (the amount of money households and firms want to hold) is a function of the interest rate. Because the interest rate is the opportunity cost of holding money balances, increases in the interest rate reduce the quantity of money that firms and households want to hold and decreases in the interest rate increase the quantity of money that firms and households want to hold. ;speculation motive One reason for holding bonds instead of money: Because the market price of interest-bearing bonds is inversely rel