Answer to Question #219030 in Marketing for saleemaslam

Question

1.     Explain how financing a persistent deficit by money creation will lead to a sustained inflation.

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2.     Explain the conclusion that the quantity theory of money is a good theory of inflation in the long run, but not in the short run. How does is this conclusion related to flexible wages and prices.

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3.     Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.

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4.     Explain the Keynesian theory of money demand. What motives did Keynes think determined money demand? What are the two reasons why Keynes thought velocity could not be treated as a constant?

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5.     Describe the factors that affect the demand for money.

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Answer 1

1.     Explain how financing a persistent deficit by money creation will lead to a sustained inflation.

Answer: Since deficit financing raises aggregate expenditure and, hence, increases aggregate demand, it creates inflation.

2.     Explain the conclusion that the quantity theory of money is a good theory of inflation in the long run, but not in the short run. How does is this conclusion related to flexible wages and prices.

Answer: if the amount of money in an economy doubles, all else equal, price levels will also double. This increase in price levels will eventually result in a rising inflation level; inflation is a measure of the rate of rising prices of goods and services in an economy. All markets reequilibrate because of adjustments in prices and wages which are flexible.

3.     Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.

Answer: It is when an increase in money does not increase income, interest rates and hence it does not stimulate economic growth. It can be problematic to policymakers because interest rates are low and savings are high, rendering money becomes ineffective.

4.     Explain the Keynesian theory of money demand. What motives did Keynes think determining money demand? What are the two reasons why Keynes thought velocity could not be treated as a constant?

Answer: He argued that demand for money is a choice between holding cash and buying bonds.  Precautionary motive, transaction motive and speculative motive. Keynes believed that demand for money depends on the interest rate and income and therefore velocity could not be treated as constant.

5.     Describe the factors that affect the demand for money.

Answer: the rate of anticipated inflation

the rate of interest rate on loans

change in GDP

the value/number of monetary transaction that we intend to carry out.