Unit 4: Money, Banking, and Monetary Policy Copyright ACDC Leadership 2015 1 The Money Market (Supply and Demand for Money) Copyright ACDC Leadership 2015 2
The Demand for Money At any given time, people demand a certain amount of liquid assets (money) for two different reasons: 1.Transaction Demand for Money- People hold money for everyday transactions. 2.Asset Demand for Money - People hold money since it is less risky than other assets What is the opportunity cost of hold keeping money in your pocket or checking account? The interest you could be earning from other financial assets like stocks, bonds, and real estate Copyright ACDC Leadership 2015
3 The Demand for Money 1. What happens to the quantity demanded of money when interest rates increase? Quantity demanded falls because individuals would prefer to have interest earning assets instead 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 There is a inverse relationship between the interest rate and the
quantity of money demanded Copyright ACDC Leadership 2015 4 The Demand for Money Inverse relationship between interest rates and the quantity of money demanded Nominal Interest Rate (ir) 20%
5% 2% 0 Copyright ACDC Leadership 2015 MD Quantity of Money (billions of dollars) 5 The Demand for Money What happens if price level increase?
Nominal Interest Rate (ir) 20% Money Demand Shifters 1. Changes in price level 2. Changes in income 3. Changes in technology 5% 2% 0 Copyright
ACDC Leadership 2015 MD1 MD Quantity of Money (billions of dollars) 6 2012 Exam The Supply for Money The U.S. Money Supply is set by the Board of Governors of the Federal Reserve System (FED) Interest
Rate (ir) 20% The FED is a nonpartisan government office that sets and adjusts the money supply to adjust the economy 5% This is called Monetary Policy. MS
2% MD 200 Copyright ACDC Leadership 2015 Quantity of Money (billions of dollars) 8 The Federal Reserve
Created in 1913, the FEDs job is to regulate banks and make sure people have faith in our financial system Copyright ACDC Leadership 2015 9 Mr. Cliffords Interview with Ben Bernanke Copyright ACDC Leadership 2015
Video: The FED Today Copyright ACDC Leadership 2015 11 Increasing the Money Supply Interest Rate (ir) MS MS1 10%
5% 2% 200 Increase money supply Copyright ACDC Leadership 2015 250 If the FED increases the
money supply, a temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall to 2% How does this affect AD? MD Quantity of Money (billions of dollars) Decreases interest rate
Increases investment Increases AD 12 Decreasing the Money Supply Interest Rate (ir) MS1 MS
If the FED decreases the money supply, a temporary shortage of money will occur at 5% interest. The shortage will cause the interest rate to rise to 10% How does this affect AD? MD Quantity of Money (billions of dollars) Increase interest rate
Decrease investment Decrease AD 13 Copyright ACDC Leadership 2015 14 2007B Practice FRQ
Copyright ACDC Leadership 2015 15 2007B Practice FRQ Copyright ACDC Leadership 2015 16 2007B Practice FRQ
Copyright ACDC Leadership 2015 17 Fractional Reserve Banking When banks hold only a small portion of deposits to cover potential withdrawals and then loans the rest of the money out. If we all went to the bank to withdrawal money at the same time what would happen? BANK RUN! Copyright ACDC Leadership 2015
18 Bank Balance Sheets Demand Deposits- Money deposited in a commercial bank in a checking account Required Reserves- The percent that banks must hold by law Excess Reserves- The amount that the bank can loan out Balance Sheet- A record of a banks assets, liabilities, and net worth. Are demand deposits in a bank an asset or
a liability? Liability for the bank, asset to the depositor Copyright ACDC Leadership 2015 19 Bank Balance Sheets Assets Loans Reserves Treasury Bonds Total Assets Liabilities
$8,000 Demand Deposits $500 Owners Equity $1,500 $10,000 Total Liabilities $5,000 $5,000 $10,000 It is balanced because the totals must equal If the bank is holding no excess reserves, how much is the required reserve ratio? .1 or 10% Copyright
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