LIQUIDITY PREFERENCE THEORY Definition (also called liquidity preference hypothesis) Observation that‚ all else being equal‚ people prefer to hold on to cash (liquidity) and that they will demand a premium for investing in non-liquid assets such as bonds‚ stocks and real estate. The theory suggests that the premium demanded for parting with cash increases as the period (term) for getting the cash back increases. The rate in the increase of this premium‚ however‚ slows down with the increase
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JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 6 • Number 1 • Summer 2007 48 Reconsidering the Introduction to Interest Rate Theory S. Kirk Elwood1 ABSTRACT The various theories of interest rate determination presented in economics textbooks each spotlight a particular fundamental force behind the equilibrium rate. Unfortunately‚ each theory’s successful emphasis of one determinant of the interest rate comes at the cost of distorting some other aspect of its determination. This paper
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(8 points) Data observation shows that the yield curve is likely to be upward sloping at the start of expansion. Explain these observations using both the bond supply and demand analysis and expectation hypothesis theory. (4 points) First the bond supply and demand analysis and data observations imply that the interest rate is procyclical. When the economy is heading for expansion‚ the bond supply increases due to more profitable investment opportunities. The bond demand increases as well‚ but
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Supply and Demand in the Market for Money: The Liquidity Preference Framework Whereas the loanable funds framework determines the equilibrium interest rate using the supply of and demand for bonds‚ an alternative model developed by John Maynard Keynes‚ known as the liquidity preference framework‚ determines the equilibrium interest rate in terms of the supply of and demand for money. Although the two frameworks look different‚ the liquidity preference analysis of the market for money is closely
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10 Money Market and the LM Curve MACROECONOMICS Macroeconomics Prof. N. Gregory MankiwRudra SensarmaKozhikode Indian Institute of Management www rudrasensarma info www.rudrasensarma.info ® PowerPoint Slides by Ron Cronovich © 2013 Worth Publishers‚ all rights reserved Learning objectives & outcomes • Money Market & the LM Curve – Real Money‚ Real Income & Interest Rate y‚ – Deriving the LM Curve – Monetary Policy & the LM Curve 2 Financial Markets (Money Market) and the LM
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Practice Exam For Spring 2013 (80 minutes) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The Bigdrill company drills for oil‚ which it sells for $200 million to the Bigoil company to be madeinto gas. The Bigoil company’s gas is sold for a total of $600 million. What is the total contribution to the country’s GDP from companies Bigdrill and Bigoil? A) $800 million B) $400 million C) $600 million D) $0 million E) $200 million 2)
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Assignment #1 Deriving the IS-LM Relation Abstract To find the IS-LM relation for an economy defined by six structural equations‚ algebra is used to derive the curves and the equilibrium conditions for these curves in relation to one another. The equations show and explain that if government spending (G) increases by EUR 150 billion‚ consumption (C) increases by EUR 50 billion‚ interest rates (i) increase by 0.05 (5%)‚ and output (Y) increases by EUR 200 billion. This causes the IS curve to shift
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Assignment 4 5. According to the IS-LM model‚ what happens to the interest rate‚ income‚ consumption and invest under the following circumstances. a. The central bank increases money supply. An increase in the money supple shifts the LM curve downward. The equilibrium moves from point A to point B. Income rises from Y1 to Y2 and the interest rate falls from r1 to r2. Therefore this increase in money supply causes a decrease in interest rate‚ an increase in income‚ an increase in consumption
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1. According to the IS-LM model‚ what happens in the short run to the interest rate‚ income‚ consumption‚ and investment under the following circumstances? (Assume everything else is held constant.) a. The central bank decreases the money supply. i. The interest rate ________increases_______________________ ii. Income ____________decreases__________________________ iii. Consumption ___________decreases______________________ iv. Investment ___________decreases________________________
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The IS ( investment and savings) schedule is a locus of points giving all the combinations of interest rate and income at which the goods market is in equilibrium‚ ceteris paribus. The IS curve is downward sloping because as interest rates fall‚ investment increases‚ thus increasing output. The steepness of the slope depends upon the sensitivity of investment to interest rate changes. The more interest sensitive the investment‚ the more interest sensitive the IS curve‚ i.e. the flatter the IS curve
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