Questions on Macro Economics

Briefly describe the three motives for holding money and the main determinants of each of these money balances. (1 5/1 5) According to the Keynesian view of money, there are three motives for holding money. These motives are transaction motives, precautionary and speculative motive. Transaction motive This is the demand for money as a medium of exchange. Money is needed for day to day expenses or day to day purchases of goods and services. Money is exchanged for goods and services that cater for the needs and wants of customers.

The goods might involve the most basic ones such as food, water and shelter as well as clothing. Precautionary motive Money as a store of value can be used to cater for uncertainties. People desire money to cater for these uncertainties that might impact on their lives. Unexpected disasters such as death, floods, hailstorms and so on may increase the demand to hold money as a precaution. However certain economic conditions such as the rate of inflation may have special implications on the demand for money for precautionary motives. If the interest rate is too high, the demand for money for precautionary motives increases.

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Speculative motive Money as a store of value can be demand as an outcome of speculation or expectations. Speculation has serious impacts on liquidity preference. The liquidity preference can be determined by several variables such as the rate of inflation and interest rate. If individuals or households for example expect a sharp increase in the price of commodities, the demand for money as a speculative motive decreases as the fear that the value of their money will be lost as a result of inflation. If people expect a sharp decrease in Questions on Macro Economics By bedfast they will be able to buy more.

Page 4 of 22 The demand to hold money as a transaction motive is known as active balance. Money held for precautionary and speculative motive is known as idle balance. In general there is an inverse relationship between holding money as idle balance and interest rate. The higher the interest rate the greater the liquidity preference or demand for money for precautionary and speculative motive. 2. 2 List the three (3) main injections into the circular flow of income and spending and two (2) leakages from the circular flow of income and spending. 5/5) Injections into the circular flow are: a. Payments made by the foreign sector to the country for exports. B. Investments by foreign firms into a country. . Government subsidies and payments for goods and services. Leakages from the circular flow of income and spending are: a. Payments for imports to the foreign sector. B. Payment of taxed to the government. QUESTION 3 [20/20] 3. 1 Keynesian Theory emphasized an active role for government in maintaining the full employment level of national incomes. An economy free of government intervention could not ensure a sufficient level of demand.

If, however, government adjusted the level of injections and withdrawals, the level of economic activity could be controlled through the multiplier effect. Briefly describe what is meant by the multiplier effect. (5/5) The multiplier effect refers to changes in national or equilibrium income or output resulting from changes if expenditure components. The result is always a multiple of the expenditure, which implies that the result is always higher that the initial charge in other words it is a multiple of the initial charge.

A change in injection, say consumption (C), investment (l), Government expenditure (G) and exports (X) results in a bigger change on the level of national output or income. The multiplier works on the portion of the injection that is handled into the circular flow. If therefore is affected by such withdrawals as savings, taxes and imports. In an open economy, the multiplier is given by the following formula: 1 1 -C (1 – t) tm Where c, t and m represent the propensities to consumer and import which are withdrawals from the circular flow. 3. Explain using an AS/AD