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We began this chapter by looking at bond and foreign exchange markets and showing how each is related to the level of real GDP and the price level. Bonds represent the obligation of the seller to repay the buyer the face value by the maturity date; their interest rate is determined by the demand and supply for bonds. An increase in bond prices means a drop in interest rates. A reduction in bond prices means interest rates have risen. The price of the dollar is determined in foreign exchange markets by the demand and supply for dollars.
We then saw how the money market works. The quantity of money demanded varies negatively with the interest rate. Factors that cause the demand curve for money to shift include changes in real GDP, the price level, expectations, the cost of transferring funds between money and nonmoney accounts, and preferences, especially preferences concerning risk. Equilibrium in the market for money is achieved at the interest rate at which the quantity of money demanded equals the quantity of money supplied. We assumed that the supply of money is determined by the Fed. An increase in money demand raises the equilibrium interest rate, and a decrease in money demand lowers the equilibrium interest rate. An increase in the money supply lowers the equilibrium interest rate; a reduction in the money supply raises the equilibrium interest rate.
How would each of the following affect the demand for money?
Compute the rate of interest associated with each of these bonds that matures in one year:
Face Value | Selling Price | |
---|---|---|
a. |
$100 |
$80 |
b. |
$100 |
$90 |
c. |
$100 |
$95 |
d. |
$200 |
$180 |
e. |
$200 |
$190 |
f. |
$200 |
$195 |
g. |
Describe the relationship between the selling price of a bond and the interest rate. |
Suppose that the demand and supply schedules for bonds that have a face value of $100 and a maturity date one year hence are as follows:
Price | Quantity Demanded | Quantity Supplied |
---|---|---|
$100 | 0 | 600 |
95 | 100 | 500 |
90 | 200 | 400 |
85 | 300 | 300 |
80 | 400 | 200 |
75 | 500 | 100 |
70 | 600 | 0 |
Compute the dollar price of a German car that sells for 40,000 euros at each of the following exchange rates:
Consider the euro-zone of the European Union and Japan. The demand and supply curves for euros are given by the following table (prices for the euro are given in Japanese yen; quantities of euros are in millions):
Price (in euros) | Euros Demanded | Euros Supplied |
---|---|---|
¥75 | 0 | 600 |
70 | 100 | 500 |
65 | 200 | 400 |
60 | 300 | 300 |
55 | 400 | 200 |
50 | 500 | 100 |
45 | 600 | 0 |
Suppose you earn $6,000 per month and spend $200 in each of the month’s 30 days. Compute your average quantity of money demanded if:
Suppose the quantity demanded of money at an interest rate of 5% is $2 billion per day, at an interest rate of 3% is $3 billion per day, and at an interest rate of 1% is $4 billion per day. Suppose the money supply is $3 billion per day.