Macroeconomics

‭Recall‬‭from‬‭Section‬‭A‬‭that‬ ‭the‬‭interest‬‭rate‬‭represents‬‭the‬‭opportunity‬‭cost‬‭of‬‭holding‬‭money‬ ‭.‬‭When‬ ‭people‬ ‭choose‬ ‭to‬ ‭hold‬ ‭money,‬ ‭they‬‭forego‬‭the‬‭interest‬‭they‬‭could‬‭have‬‭earned‬‭from‬‭a‬‭bond‬‭or‬‭savings‬ ‭account.‬‭In‬‭essence,‬ ‭the‬‭nominal‬‭interest‬‭rate‬‭serves‬‭as‬‭the‬‭“price”‬‭of‬‭money‬ ‭.‬‭This‬‭choice‬‭of‬‭using‬‭the‬ ‭nominal‬ ‭interest‬ ‭rate‬ ‭is‬ ‭because,‬ ‭in‬ ‭practice,‬ ‭individuals‬ ‭do‬ ‭not‬‭always‬‭have‬‭perfect‬‭knowledge‬‭of‬‭the‬ ‭current‬ ‭inflation‬ ‭rate‬ ‭(real‬ ‭interest‬ ‭rate‬‭=‬‭nominal‬‭interest‬‭rate‬‭−‬‭inflation‬‭rate).‬‭Instead,‬‭they‬‭evaluate‬ ‭the value of the money they hold in their hands right now, which is why the nominal interest rate is used.‬ ‭The Money Demand Curve‬ ‭When‬‭interest‬‭rates‬‭are‬‭high,‬‭people‬‭tend‬‭to‬‭favor‬‭investing‬‭in‬‭bonds‬‭over‬‭holding‬‭cash‬‭because‬‭bonds‬ ‭provide‬‭interest‬‭payments‬‭(coupon‬‭payments)‬‭that‬‭boost‬‭overall‬‭returns.‬‭In‬‭contrast,‬‭when‬‭interest‬‭rates‬ ‭are‬‭low,‬‭people‬‭prefer‬‭holding‬‭onto‬‭cash.‬ ‭This‬‭inverse‬‭relationship‬‭between‬‭the‬‭nominal‬‭interest‬‭rate‬ ‭and‬ ‭the‬ ‭quantity‬ ‭demanded‬ ‭of‬ ‭money‬ ‭results‬ ‭in‬ ‭a‬ ‭downward-sloping‬ ‭demand‬ ‭curve‬ ‭(Md).‬ ‭The‬ ‭nominal‬‭interest‬‭rate‬‭(N.i.r)‬‭is‬‭plotted‬‭on‬‭the‬‭vertical‬‭axis,‬‭while‬‭the‬‭quantity‬‭of‬‭money‬‭is‬‭plotted‬‭on‬‭the‬ ‭horizontal axis.‬

‭A‬ ‭change‬ ‭in‬ ‭the‬ ‭nominal‬ ‭interest‬ ‭rate‬ ‭causes‬ ‭a‬ ‭movement‬ ‭along‬ ‭the‬ ‭money‬ ‭demand‬ ‭curve‬ ‭.‬ ‭The‬ ‭higher the interest rate, the lower the quantity demanded of money, and vice versa.‬

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