PRINCIPLES OF MACROECONOMICS PART III The Core of Macroeconomic Theory TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 25 PART III The Core of Macroeconomic Theory © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 Money Demand and the Equilibrium Interest Rate 11 CHAPTER OUTLINE Interest Rates and Bond Prices The Demand for Money The Transaction Motive The Speculation Motive The Total Demand for Money The Effect of Nominal Income on the Demand for Money PART III The Core of Macroeconomic Theory The Equilibrium Interest Rate © 2012 Pearson Education, Inc Publishing as Prentice Hall Supply and Demand in the Money Market Changing the Money Supply to Affect the Interest Rate Increases in P • Y and Shifts in the Money Demand Curve Zero Interest Rate Bound Looking Ahead: The Federal Reserve and Monetary Policy Appendix A: The Various Interest Rates in the U.S Economy Appendix B: The Demand for Money: A Numerical Example of 39 Interest Rates and Bond Prices interest The fee that borrowers pay to lenders for the use of their funds Firms and governments borrow funds by issuing bonds, and they pay interest to the lenders that purchase the bonds PART III The Core of Macroeconomic Theory When interest rates rise, the prices of existing bonds fall © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 ECONOMICS IN PRACTICE Professor Serebryakov Makes an Economic Error PART III The Core of Macroeconomic Theory 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 © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 The Demand for Money When we speak of the demand for money, we are concerned with how much of your financial assets you want to hold in the form of money, which does not earn interest, versus how much you want to hold in interest-bearing securities such as bonds PART III The Core of Macroeconomic Theory The Transaction Motive transaction motive The main reason that people hold money—to buy things nonsynchronization of income and spending The mismatch between the timing of money inflow to the household and the timing of money outflow for household expenses © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 The Demand for Money PART III The Core of Macroeconomic Theory The Transaction Motive FIGURE 11.1 The Nonsynchronization of Income and Spending Income arrives only once a month, but spending takes place continuously © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 The Demand for Money PART III The Core of Macroeconomic Theory The Transaction Motive FIGURE 11.2 Jim’s Monthly Checking Account Balances: Strategy 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 © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 PART III The Core of Macroeconomic Theory Jim receives $1,200 per month (30 days) and spends $40 each day What is his average money balance? a $40 b $30 c $600 d $1,200 © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 PART III The Core of Macroeconomic Theory Jim receives $1,200 per month (30 days) and spends $40 each day What is his average money balance? a $40 b $30 c $600 d $1,200 © 2012 Pearson Education, Inc Publishing as Prentice Hall 10 of 39 ... Prentice Hall 18 of 39 ECONOMICS IN PRACTICE ATMs and the Demand for Money PART III The Core of Macroeconomic Theory Italy makes a great case study of the effects of the spread of ATMs on the demand... Education, Inc Publishing as Prentice Hall 17 of 39 PART III The Core of Macroeconomic Theory Which of the following is a better measure of the opportunity cost of holding money balances? a The demand... 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 © 2012 Pearson Education, Inc Publishing as Prentice Hall of 39 PART