UNIT IV
Question Bank:
Q1) Define Price.
Ans. Prices are measures of the amount of money that one has to give up to obtain units of goods and services. When this macro measurement is extended to the entire economy, we get the concept of general price level.
The price level measures the amount of money that has to be given up to obtain a unit of the average good in the economy, or to obtain one unit of the total output.
The inverse or reciprocal of the price level represents value of money, or what a unit of money can buy. This is referred to as the real value of money or its purchasing power. Study of the factors that determine the price level and thus, the value of money, is one of the important subject matter of macro economics.
Different views on what determines the price have been put forward by different economist. Though they may differ in their approaches, most have concluded that the price level is determined by the supply of money and demand for money. The demand- supply analysis of price level determination at macro- level is essentially different from the demand- supply analysis of price determination at the micro-level for an individual good. Goods produced are flows while money can be both stock and flow.
The quantity theory of money was used by economists to explain changes in general price level. They believed that the quantity of money in the economy was the prime factor determining price level. Any change in the quantity of money would bring about a change in the general level. The theory is based directly on the changes brought about by an increase in the money supply. The quantity theory of money states that the value of money is based on the amount of money in the economy.
Q2) Explain the Fisher equation of money.
Ans . The Fisher equation is calculated:
M×V=P×T
Where:
M=money supply
V=velocity of money
P=average price level
T=volume of transactions in the economy
Q3) What is the amount of money theory?
Ans. Financial Theory refers to plan the amount of accessible money (money supply) grows at the same rate as the price level in the long run. With lower interest rates, lower taxes, and no longer limited access to money, consumers are less sensitive to price changes and have a higher consumption trend. As a result, the aggregate demand curve shifts to the right, shifting up the equilibrium price level. Replaceable
To better understand the theory of the amount of money, you can use the exchange equation:
The formula is the Economist model with the relationship between gold supply and price. The replacement formula is:
Where,
M-refers to the money supply
V-refers to the rate of money that measures how much a single dollar of money supply contributes to GDP
P-refers to the prevailing price level
Q-refers to the amount of goods and services produced in the economy
If we keep Q and V constant, we can see that an increase in the money supply increases the price level and causes inflation. The assumption that Q and V are constant holds in the long run, since these factors cannot be affected by changes in the money supply of the economy.
This theory provides a brief overview of the monetarist theory, which states that changes in the current money supply cause fluctuations in overall economic production and that excessive growth in the money supply causes an increase in inflation.
Q4) Explain the exchange equation of demand for money.
Ans. The exchange equation can also be modified into the equation of demand for money as follows:
Where,
Md-refers to the demand for money
P-refers to the price level of the economy
Q-refers to the amount of goods and services offered in the economy
V-refers to the speed of money
In this formula, the molecular term (P x Q) refers to the nominal GDP of the country. Moreover, the equation provides another take on the monetarist theory because it associates GDP with the demand for money (contrary to Keynesian economists who believe that interest rates cause inflation).
Q5) What are the Limitations of portfolio theory?
Ans. Limitations of portfolio theory:
The usefulness of portfolio theory in studying the demand for money depends on which measure of cash supply is employed.
Portfolio theory of money demand is only plausible when adopting a broad measure of money supply (M2)):
Because this is:
M1 is a narrow measure of money because it includes only coins and currencies and demands deposits with people earning very low or no interest rates.
M1=currency +demand deposit
Thus the portfolio theory helps to include only one (M2) measure of the gold supply:
M2=M1 + savings account +money market mutual fund.
Q6) What do you mean by Cash balance approach of money?
Ans. The Cambridge version of quantity theory of money was first developed by Alfred Marshall and later modified by A.C Pigou and D.H Robertson. Since all these economists were from the Cambridge University, their version of the quantity theory came to be known as the Cambridge Version. This version is an improvement over the classical cash transactions approach. The cash balance approach provided the basis for Keynes to develop his famous Liquidity Preference Theory of Money.
According to the Cambridge version, people demand to hold money not only for transactions but also because money’s function as a ‘store of value’. Therefore, real demand for money is for transaction as well as other purposes. When money is held or hoarded, it has utility as it acquires wealth value. The amount of cash balances held by people is determined by their real value, or the purchasing power of the balances held. People will want to hold money not for the money’s sake but for the command that money has over real resources and goods.
Taken together, the community’s total demand for cash balances constitutes a certain proportion of the country’s real national income. This proportion is represented by the letter k’ in the Cambridge equation. It represents a proportion of the total real income (output produced) that people of the country demand to hold in the form of cash balances.
If we assume that in an economy, the volume of transactions are given over a period of time, the community’s total demand for real cash balances may be represented by a certain proportion (k) of the annual real national income (Y).
The proportion k, known as ‘Cambridge k’ is determined by individuals and groups of individuals on the basis of several factors like spending pattern, price level, rate of interest, general economic condition, the opportunity cost of holding cash. When people want to hold more cash, they spend less on goods and services. This lowers the demand for goods and services and price level falls. Similarly, if people want to hold less cash and spend more on transacting in goods and services, the price level will rise. Price level falls. Similarly, if people want to hold less cash and spend more on transacting in goods and services, the price level will rise. Price level determines the value of money. Higher the price level, lower will be the purchasing power of one unit on money, and vice versa.
The Cambridge version is represented by the following equation:
Md = kPY
Where,
Md = community’s demand for money
Y = real national output
P = average price (general price level)
k = proportion of national output or income that people want to hold
Let assume that money supply Ms is determined by monetary authorities
Ms = M
At full employment equilibrium, supply of money is equal to demand for money.
Ms = Md
Or
M = kPY
P = M/kY
Where,
K and y are independent of money supply
K is constant and is given by transactions demand for money
Y is constant at full employment
P and money supply M are directly proportional. If money supply is doubled, so will P and if money supply is halved, P will also be halved.
Q7) What is the Fisher equation?
Ans. The Fisher equation is a concept in economics that describes the relationship between nominal and real interest rates affected by inflation. The formula states that the nominal interest rate is equal to the sum of the real interest rate and the rate of inflation.
The Fisher equation is often used in situations where investors and lenders seek additional compensation to compensate for the loss of purchasing power due to high inflation. This concept is widely used in the field of Finance and economics. It is often used when calculating returns on investments or predicting the behavior of nominal and real interest rates. One example is when an investor wants to determine the actual (actual) interest rate earned on an investment after considering the impact of inflation.
One of the particularly important implications of the Fisher equation is related to monetary policy. This formula reveals that monetary policy moves inflation and nominal interest rates together in the same direction. On the other hand, monetary policy generally does not affect real interest rates. American economist Irving Fisher proposed the Fisher equation to the equation
Q8) Explain the Fisher’s equation with the help of equation.
Ans. The Fisher equation is represented by the following equation:
(1+i)=(1+r)(1+∞)
Where
I-nominal interest rates
r-real interest rates
① –Inflation rate
However, you can also us
e an approximate version of the previous expression:
i∩r+∩
Q9) Give one example of Fisher equation.
Ans. Last year, when Sam owned an investment portfolio, the portfolio earned a return of 3.25 per cent. But last year inflation was about 2%. Sam wants to determine the real returns he has earned from his portfolio. To find the real rate of Return, use the Fisher equation. The equation says:
(1+i)=(1+r) (1+∞)you can sort the equation to find the real interest rate: therefore, the real interest rate of the portfolio, or the real return on investment, after accounting for inflation.
Therefore, the real interest rate that Sam's investment portfolio earned last year is 1.26%.
Q10) How can you explain the exchange equation of money?
Ans. To better understand the theory of the amount of money, you can use the exchange equation:
The formula is the Economist model with the relationship between gold supply and price. The replacement formula is:
Where,
M-refers to the money supply
V-refers to the rate of money that measures how much a single dollar of money supply contributes to GDP
P-refers to the prevailing price level
Q-refers to the amount of goods and services produced in the economy
If we keep Q and V constant, we can see that an increase in the money supply increases the price level and causes inflation. The assumption that Q and V are constant holds in the long run, since these factors cannot be affected by changes in the money supply of the economy.
This theory provides a brief overview of the monetarist theory, which states that changes in the current money supply cause fluctuations in overall economic production and that excessive growth in the money supply causes an increase in inflation.
UNIT IV
Question Bank:
Q1) Define Price.
Ans. Prices are measures of the amount of money that one has to give up to obtain units of goods and services. When this macro measurement is extended to the entire economy, we get the concept of general price level.
The price level measures the amount of money that has to be given up to obtain a unit of the average good in the economy, or to obtain one unit of the total output.
The inverse or reciprocal of the price level represents value of money, or what a unit of money can buy. This is referred to as the real value of money or its purchasing power. Study of the factors that determine the price level and thus, the value of money, is one of the important subject matter of macro economics.
Different views on what determines the price have been put forward by different economist. Though they may differ in their approaches, most have concluded that the price level is determined by the supply of money and demand for money. The demand- supply analysis of price level determination at macro- level is essentially different from the demand- supply analysis of price determination at the micro-level for an individual good. Goods produced are flows while money can be both stock and flow.
The quantity theory of money was used by economists to explain changes in general price level. They believed that the quantity of money in the economy was the prime factor determining price level. Any change in the quantity of money would bring about a change in the general level. The theory is based directly on the changes brought about by an increase in the money supply. The quantity theory of money states that the value of money is based on the amount of money in the economy.
Q2) Explain the Fisher equation of money.
Ans . The Fisher equation is calculated:
M×V=P×T
Where:
M=money supply
V=velocity of money
P=average price level
T=volume of transactions in the economy
Q3) What is the amount of money theory?
Ans. Financial Theory refers to plan the amount of accessible money (money supply) grows at the same rate as the price level in the long run. With lower interest rates, lower taxes, and no longer limited access to money, consumers are less sensitive to price changes and have a higher consumption trend. As a result, the aggregate demand curve shifts to the right, shifting up the equilibrium price level. Replaceable
To better understand the theory of the amount of money, you can use the exchange equation:
The formula is the Economist model with the relationship between gold supply and price. The replacement formula is:
Where,
M-refers to the money supply
V-refers to the rate of money that measures how much a single dollar of money supply contributes to GDP
P-refers to the prevailing price level
Q-refers to the amount of goods and services produced in the economy
If we keep Q and V constant, we can see that an increase in the money supply increases the price level and causes inflation. The assumption that Q and V are constant holds in the long run, since these factors cannot be affected by changes in the money supply of the economy.
This theory provides a brief overview of the monetarist theory, which states that changes in the current money supply cause fluctuations in overall economic production and that excessive growth in the money supply causes an increase in inflation.
Q4) Explain the exchange equation of demand for money.
Ans. The exchange equation can also be modified into the equation of demand for money as follows:
Where,
Md-refers to the demand for money
P-refers to the price level of the economy
Q-refers to the amount of goods and services offered in the economy
V-refers to the speed of money
In this formula, the molecular term (P x Q) refers to the nominal GDP of the country. Moreover, the equation provides another take on the monetarist theory because it associates GDP with the demand for money (contrary to Keynesian economists who believe that interest rates cause inflation).
Q5) What are the Limitations of portfolio theory?
Ans. Limitations of portfolio theory:
The usefulness of portfolio theory in studying the demand for money depends on which measure of cash supply is employed.
Portfolio theory of money demand is only plausible when adopting a broad measure of money supply (M2)):
Because this is:
M1 is a narrow measure of money because it includes only coins and currencies and demands deposits with people earning very low or no interest rates.
M1=currency +demand deposit
Thus the portfolio theory helps to include only one (M2) measure of the gold supply:
M2=M1 + savings account +money market mutual fund.
Q6) What do you mean by Cash balance approach of money?
Ans. The Cambridge version of quantity theory of money was first developed by Alfred Marshall and later modified by A.C Pigou and D.H Robertson. Since all these economists were from the Cambridge University, their version of the quantity theory came to be known as the Cambridge Version. This version is an improvement over the classical cash transactions approach. The cash balance approach provided the basis for Keynes to develop his famous Liquidity Preference Theory of Money.
According to the Cambridge version, people demand to hold money not only for transactions but also because money’s function as a ‘store of value’. Therefore, real demand for money is for transaction as well as other purposes. When money is held or hoarded, it has utility as it acquires wealth value. The amount of cash balances held by people is determined by their real value, or the purchasing power of the balances held. People will want to hold money not for the money’s sake but for the command that money has over real resources and goods.
Taken together, the community’s total demand for cash balances constitutes a certain proportion of the country’s real national income. This proportion is represented by the letter k’ in the Cambridge equation. It represents a proportion of the total real income (output produced) that people of the country demand to hold in the form of cash balances.
If we assume that in an economy, the volume of transactions are given over a period of time, the community’s total demand for real cash balances may be represented by a certain proportion (k) of the annual real national income (Y).
The proportion k, known as ‘Cambridge k’ is determined by individuals and groups of individuals on the basis of several factors like spending pattern, price level, rate of interest, general economic condition, the opportunity cost of holding cash. When people want to hold more cash, they spend less on goods and services. This lowers the demand for goods and services and price level falls. Similarly, if people want to hold less cash and spend more on transacting in goods and services, the price level will rise. Price level falls. Similarly, if people want to hold less cash and spend more on transacting in goods and services, the price level will rise. Price level determines the value of money. Higher the price level, lower will be the purchasing power of one unit on money, and vice versa.
The Cambridge version is represented by the following equation:
Md = kPY
Where,
Md = community’s demand for money
Y = real national output
P = average price (general price level)
k = proportion of national output or income that people want to hold
Let assume that money supply Ms is determined by monetary authorities
Ms = M
At full employment equilibrium, supply of money is equal to demand for money.
Ms = Md
Or
M = kPY
P = M/kY
Where,
K and y are independent of money supply
K is constant and is given by transactions demand for money
Y is constant at full employment
P and money supply M are directly proportional. If money supply is doubled, so will P and if money supply is halved, P will also be halved.
Q7) What is the Fisher equation?
Ans. The Fisher equation is a concept in economics that describes the relationship between nominal and real interest rates affected by inflation. The formula states that the nominal interest rate is equal to the sum of the real interest rate and the rate of inflation.
The Fisher equation is often used in situations where investors and lenders seek additional compensation to compensate for the loss of purchasing power due to high inflation. This concept is widely used in the field of Finance and economics. It is often used when calculating returns on investments or predicting the behavior of nominal and real interest rates. One example is when an investor wants to determine the actual (actual) interest rate earned on an investment after considering the impact of inflation.
One of the particularly important implications of the Fisher equation is related to monetary policy. This formula reveals that monetary policy moves inflation and nominal interest rates together in the same direction. On the other hand, monetary policy generally does not affect real interest rates. American economist Irving Fisher proposed the Fisher equation to the equation
Q8) Explain the Fisher’s equation with the help of equation.
Ans. The Fisher equation is represented by the following equation:
(1+i)=(1+r)(1+∞)
Where
I-nominal interest rates
r-real interest rates
① –Inflation rate
However, you can also us
e an approximate version of the previous expression:
i∩r+∩
Q9) Give one example of Fisher equation.
Ans. Last year, when Sam owned an investment portfolio, the portfolio earned a return of 3.25 per cent. But last year inflation was about 2%. Sam wants to determine the real returns he has earned from his portfolio. To find the real rate of Return, use the Fisher equation. The equation says:
(1+i)=(1+r) (1+∞)you can sort the equation to find the real interest rate: therefore, the real interest rate of the portfolio, or the real return on investment, after accounting for inflation.
Therefore, the real interest rate that Sam's investment portfolio earned last year is 1.26%.
Q10) How can you explain the exchange equation of money?
Ans. To better understand the theory of the amount of money, you can use the exchange equation:
The formula is the Economist model with the relationship between gold supply and price. The replacement formula is:
Where,
M-refers to the money supply
V-refers to the rate of money that measures how much a single dollar of money supply contributes to GDP
P-refers to the prevailing price level
Q-refers to the amount of goods and services produced in the economy
If we keep Q and V constant, we can see that an increase in the money supply increases the price level and causes inflation. The assumption that Q and V are constant holds in the long run, since these factors cannot be affected by changes in the money supply of the economy.
This theory provides a brief overview of the monetarist theory, which states that changes in the current money supply cause fluctuations in overall economic production and that excessive growth in the money supply causes an increase in inflation.
