Unit 4

Demand for Money

• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded.
1. What happens to the quantity demand of money when interest rate increase?
   Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.
2. What happens to the quantity demanded when interest rates decrease?
   Quantity demanded increases there is no incentive to convert cash into interest earning assets.
• Money Demand Shifters
1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment
• Increasing the Money Supply
• If the FED increases the money supply, a temporary surplus of money will occur a 5% interest.
• The surplus will cause the interest rate to fall to 10%.
• Decreasing the Money Supply
• If the FED decreases the money supply, a temporary shortage of money will occur a 5% interest.
• The shortage will cause the interest rate to rise to 10%.
• How does this affect AD?
  Decrease money supply→Increase interest rate→Decrease investment→Decrease AD

Financial Sector

• Financial Assets vs. Financial Liabilities
• Financial Assets: stocks and bonds whose benefit to the owner depends upon the issuer of the asset meeting certain obligations.
• Financial Liabilities: liabilities incurred by the issuer of a financial asset to stand behind the issued asset.
• Interest Rate: the price paid of a use of a financial asset
• Stocks vs. Bonds
• Stocks: a financial asset that conveys ownership in a corporation
• Bonds: a promise to pay a certain amount of money plus interest in the future.