HOMEWORK 6

The impact of economic fluctuations on the economy’s real output and price level in both the short run and long run

K

·         Consumers will spend more with a decrease in price level (increase GDP)

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 Decrease in price level causes a decrease in interest rate which encourages greater spending on investment. (increase GDP)

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Decrease in price level will decrease interest rate and decrease real value of dollar in F.E markets, dec NX

·         Economic fluctuations implies fluctuations in the major economic indicators like GDP, National income, Price level, etc. These indicators will increase during the peak periods & decrease during the recessionary periods. So the ups & down swings in the economic activities like investment, consumption, employment & in economic indicators are referred as economic fluctuations.

·         It is the ups and downs of the value of our dollar.
Currently the stock market and other financial investments (eg. businesses, employment , funds, bonds, etc. These financial indicators move up in down in value and are somewhat unstable.

·         Small but frequent changes in economic variables

·         For a quarter of a century, fiscal policy had been the neglected stepchild of government management of the economy. Monetary policy—essentially controlling interest rates—had become not merely the preferred policy tool to counteract either recession or economic overheating but, in the minds of many theoreticians and policymakers, the only effective countercyclical policy tool.

W

·         How It is the ups and downs of the value of our dollar

·         How it affects the private sector

·         How it affects the public sector

·         Are there policies in place to regulate it

·         What are the main effects of economic fluctuations

·         How often do they happen

·         What do they happen as a result of

L

·         Economic fluctuations implies fluctuations in the major economic indicators like GDP, National income, Price level, etc. These indicators will increase during the peak periods & decrease during the recessionary periods. So the ups & down swings in the economic activities like investment, consumption, employment & in economic indicators are referred as economic fluctuations.

·         Economic fluctuation is a part of the business or economic cycle, and refers to the economy-wide fluctuations in production, trade, and all other economic activity. This takes place in often free-enterprise principles.

·         Economic fluctuation is a part of the business or economic cycle, and refers to the economy-wide fluctuations in production, trade, and all other economic activity. This takes place in often free-enterprise principles.

Understand to define the four functions of money

K

·         Money is any good that is widely accepted in exchange of goods and services, as well as payment of debts. Most people will confuse the definition of money with other things, like income, wealth, and credit. Three functions of money are:

1. Medium of exchange: Money can be used for buying and selling goods and services. If there were no money, goods would have to be exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the basis of mutual need). For example: If I raise chickens and want to buy cows, I would have to find a person who is willing to sell his cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of the double coincidence of wants.
2. Unit of account: Money is the common standard for measuring relative worth of goods and service.
3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be spent to buy goods and services). Money’s value can be retained over time. It is a convenient way to store wealth.

W

·         How is money regulated

·         How is money circulated

·         Who authorizes the distribution of money

·         How do the functions of money affect the economy

·         Why is money a better medium of exchange

·         What influences the worth of a dollar

L

In the real world, money supply has different definitions: M1 and M2. Money is categorized according to its liquidity. The most liquid items are in M1.

M1: includes currency (coins minted by the U.S. Treasury and paper currency issued by the Federal Reserve), checkable deposits and traveler’s checks (issued by the commercial banks and thrift institutions).

Currency and checkable deposits belonging to the federal government, Federal Reserve, or other financial institutions are not included in M1.

M1 = Currency + Checkable deposits + Traveler’s checks

M2: includes all of the components of M1 plus near-moneys which includes items like:

a) Small Time deposits: interest-earning deposits with a value of less than $100,000, and having a specified maturity.

b) Savings deposits: interest-earning deposits with no specific maturity of maximum value.

c) Money market accounts: savings that invest in short-term financial instruments, pay higher than savings account interest.

d) Overnight repurchase agreements: agreements by a financial institutions to sell short –term securities to its customers, accompanied by an agreement to repurchase the securities within 24 hours.

e) Overnight Eurodollar deposits: 24-hour dollar-denominated deposits held in financial institutions outside the United States.

K

Understand to explain what is meant by “transaction” and “asset” demand for money

·         Transactions demand, in economic theory, specifically Keynesian economics, is one of the determinants of demand for money (and credit), the others beingspeculative demand and precautionary demand. Transactions demand is illustrated as a vertical line on the money demand graph. The demand of money has arisen from the absence of perfect synchronization of payments and receipts. The holding of money is to bridge the gap between payments and receipts. Transactiondemand for money is due to the household's motive to hold money for daily transaction and the business's motive to facilitate the daily operation. The transactions demand for money is positively related with the amount of real income. It also depends on the timing of expenditures and the length of the payment period.

·         The amount of money needed to cover the needs of an individual, firm, or nation. That is, transaction demand for money is a measure of how much of a certain currency people need in order to buy the goods and services they use. Generally speaking, if an economy is healthy, there is a high transaction demand for money because people are buying more goods and services. Conversely, if an economy is in trouble, people buy fewer goods and services. Unless there is a significant, sudden change in the transaction demand, central banks have little trouble adjusting the money supply to accommodate the changes that do occur.

·         On a daily basis people need money on hand for the things that they routinely buy. You have to get a haircut or stop by the store on the way home from work to pick up some milk. You have transactions that you need to conduct, and therefore you have a demand for money. The transactions demand for money is using money as a medium of exchange. Notice in the graph below that the Transactions Demand for Money (DMT) is denoted as a vertical line when graphed against the interest rate. The demand for money as a medium of exchange is independent of the interest rate, because when you are on your way home from work and need to pick up milk, the interest rate does not affect how much milk you buy.

·         Some people hold money as a financial asset just like stocks and bonds. Holding money as a liquid asset is using money as a store of value. Consider a person who has a portfolio of investments. Perhaps he owns some stocks, bonds, jewelry, artwork, a home, a savings account at his credit union, and has $5,000 in a fireproof box hidden in his basement. In an emergency, the cash is the most liquid asset that the person has, and is far more spendable than a painting or a piece of jewelry that might take weeks to turn into cash.  The liquidity of cash is the advantage of holding cash. The disadvantage of holding money as an asset is that there is very little or no return on this asset. 

W

·         What is the inverse relationship between interest rate and asset demand for money?

·         What is considered asset money?

·         How can the DMT be further explained

L

·         The cost of holding money as an asset is the foregone interest rate and there is an inverse relationship between the interest rate and the asset demand for money. This inverse relationship is illustrated in the graph below as a downward sloping asset demand for money (DMA). The total demand of money (DM) is just the sum of the transactions demand and the asset demand, and has the same downward slope as the asset demand.

·         Asset demand for money is amount of money that people want so they can hold money as assets. The asset demand for money is inversely proportional to the interest rate. The reason