Check Your Understanding

1. Question

   Explain how each of the following would affect the quantity of money demanded, and indicate whether each change would cause a movement along the money demand curve or a shift of the money demand curve.

   1. The short-term interest rate rises from 5% to 30%.

      By increasing the opportunity cost of holding money, a high interest rate reduces the quantity of money demanded. This is a movement up and to the left along the money demand curve.

   2. All prices fall by 10%.

      A 10% fall in prices reduces the quantity of money demanded at any given interest rate, shifting the money demand curve leftward.

   3. New wireless technology automatically charges supermarket purchases to credit cards, eliminating the need to stop at the cash register.

      This technological change reduces the quantity of money demanded at any given interest rate, so it shifts the money demand curve leftward.

   4. In order to avoid paying taxes, a vast underground economy develops in which workers are paid their wages in cash rather than with checks.

      Payments in cash require employers to hold more money, increasing the quantity of money demanded at any given interest rate. Thus, it shifts the money demand curve rightward.

2. Question

   How will each of the following affect the opportunity cost or benefit of holding cash? Explain.

   1. Merchants charge a 1% fee on debit/credit card transactions for purchases of less than $50.

      A 1% purchase fee on debit/credit card transactions for purchases less than $50 increases the benefit of holding cash because consumers will save money by paying with cash.

   2. To attract more deposits, banks raise the interest paid on six-month CDs.

      An increase in the interest paid on six-month CDs raises the opportunity cost of holding cash because holding cash requires forgoing the higher interest paid.

   3. The cost of food rises significantly.

      Because many purchases of food are made in cash, a significant increase in the cost of food increases the benefit of holding cash.