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1、Chapter 9: The Demand for Money and the LM CurveProblem 1As real balances rise, the marginal utility of money falls. As a result, interest rates must fall in order to encourage the holding of larger levels of real balances, which generates a downward sloping money demand curve.Problem 2Ymax is the m
2、aximum possible income of a household if it chooses to hold all of its wealth in interest-bearing corporate bonds:Ymax = i + 兰 L,P Pwhere W/P is the households real wealth, w/P is the real wage rate, and L is the amount of labor supplied during a typical week.The price of a bond, PB, enters the vari
3、able YM AX through wealth, W, sinceW = M + PbB.Therefore, an increase in the price of bonds will increase the households wealth, everything else remaining the same, and hence increase YMAX. The households wealth increases because an increase in price of bonds increases the value of corporate bonds t
4、hat (he household already owns. Therefore, the bond price increase will shift the budget line to the right, in a parallel fashion.Problem 3The velocity of circulation is lhe number of times a year that lhe average dollar bill circulates in the economy and is measured in fractions of I /years. The pr
5、opensity to hold money is the fraction of a years nominal income held as money and is measured in fractions of a year. For example, if k=l/5 of a years income, then v=5, which means that the average bill changes 5 times a year.Problem 4See Box 9.2 in the text. In the data there is a close positive r
6、elationship between the nominal interest rate and velocity, just like the utility theory of money demand predicts. This compares favorably to the predictions of the quantity theory, which assumed that velocity was constant and that there should be no relationship between interest rates and velocity.
7、In the utility theory of money demand, it is the nominal interest rate (hat determines the level of money demand. The nominal interest rate is the opportunity cost of holding real balances because the nominal interest rate incorporates not just the lost real return of holding money as opposed to hol
8、ding bonds but also incorporates inflation that decreases the real value of money holdings.Problem 6In the classical model, the real interest rate is determined in the capital market, where saving supply and investment demand determine the equilibrium real interest rate. In the new-Keynesian model,
9、it is (he nominal interest rate that is matters. The nominal interest rate is the opportunity cost, or price, of holding money and is determined by equating money supply with money demand.Problem 7In response to an increase in the money supply, nominal interest rates in the money market will fall. T
10、his is consistent with the real world behavior of interest rates in response to Federal Reserve policy, which w山 be discussed more fully in Chapter 10.Problem 8In the classical model, changes in the money supply have no real effects because of money neutrality. Changes in the money supply only lead
11、to changes in the price level. As a result of an increase in the money supply, the real interest rate remains unchanged but the nominal interest rale should increase as inflation increases. This is not consistent with what happens in the real world, where increases in the money supply lead (o decrea
12、ses in nominal interest rates. This is a big problem with the classical models explanation of interest rates.Problem 9Usually money demand increases during the Christmas season because of the large increase in purchases. This increase in money demand will put upward pressure on nominal interest rate
13、s. To offset this, the monetary authority should increase the money supply to keep interest rates at their current level.Problem 10The LM curve is upward sloping because an increase in output increases money demand, which in turn increases the equilibrium interest rate. See Figure 9.4 in the text.Ac
14、cording to the classical model, money neutrality holds and there is no relationship between the level of nominal variables and the level of real variables. As a result, the nominal interest rate has no effect on real output and the LM curve is a vertical line. In the utility theory of money demand,
15、nominal interest rates do have an effect on the real demand fbr money balances and as a result money neutrality does not hold and the LM curve is upward sloping.Problem 12A decrease in the price level increases the real supply of money. This increase in (he real money supply reduces nominal interest
16、 rates. The LM curve shifts to the right towards lower nominal interest rates for a given level of output. See Figure 9.5 in the text.Problem 13A proportional increase in both the price level and lhe money supply leaves the real money supply unchanged. As a result, there is no change in the money market, no change in nominal interest rates, and no change in the LM curve.Problem 14Setting Md/P = Ms/P, the LM curve is Y = 500 + 200i. Notice that there is
