Question

In terms of the speculative demand for money, how would abnormal and extremely low interest rates be viewed by agents?

a)agents would expect the interest rate to rise in the future, providing a capital gain on bonds, agents hold less money and more bonds

b)agents would expect the interest rate to rise in the future, providing a capital lose on bonds, agents hold more money and fewer bonds

c)agents view low interest rates as a great time to refinance their home

d)agents use low interest rates to borrow more money investing abroad at higher rates

2)

Which of the following express equilibrium in the product market?

		Y=E
		Y=C+I+G+NX
		S+T+M=I+G+X
		all of the above

3)

Under which set of conditions is fiscal policy most effective?

		a vertical LM curve
		a steep IS curve and relatively flat LM curve
		a relatively flat IS curve and steep LM curve
		steep IS and LM curves

Answer 1

1)b.............. because, Speculative demand is the holding of real balances for the purpose of avoiding capital loss from holding bonds or stocks. The speculative demand for money is inversely related to the market interest rate. This is because at a lower interest rate, more people will expect a rise in the interest rate (and thus a fall in aftermarket bond prices). As a result, more people will hold their wealth in money rather than bonds, i.e. the speculative balances will be greater at a lower interest rate. It also depends on investors' aversion to risk, the relative demand for and the supply of other financial assets and real assets, and the change in expectations of the economic climate.

2)d......all the above........... because, equilibrium in the product market is reached when aggregate demand for output. At a given price level the consumers, businessmen and government are the demanders for output and the business sector is its supplier.

3)b.............. because, Fiscal policy is more effective, the flatter is the LM curve, and is less effective when the LM curve is steeper. When the IS curve shifts upwards to IS1with the increase in gov­ernment expenditure, its impact on the national income is more with the flatter LM curve than with the steeper LM curve. Fiscal policy is completely ineffective, if the LM curve is vertical or horizontal.