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Classical Economics

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Text 3

Text 2

Read the text and and think of a proper title for it.

Monetary policy is a central government policy with respect to the quantity of money in the economy, the rate of interest and the exchange rate.

Let us consider the demand and supply for money.

Why do people hold (demand) currency and checkable deposits (M1), rather than putting their money to work in stocks, bonds, real estate, or other nonmoney forms of wealth? John Maynard Keynes, in his 1936 work entitled The General Theory of Employment, Interest, and Money, gave three important motives for doing so: transactions demand, precautionary demand, and speculative demand.

The transactions demand for money is the stock of money people hold to pay everyday predictable expenses. The desire to have "walking around money" to make quick and easy purchases is the principal reason for holding money. Without enough cash, the public must suffer forgone interest.

People have a second motive to hold money, called the precautionary demand for money. The precautionary demand for money is the stock of money held to pay unpredictable expenses. This is the "mattress money" people hold to guard against those proverbial rainy days.

The third motive for holding money is the speculative demand.The speculative demand for money is the stock of money held to take advantage of expected future changes in the price of bonds, stocks, or other non-money financial assets. It is the so called “betting money.

As the interest rate falls, the opportunity cost of holding money falls, and people increase their speculative balances.

Money supplycomes in many forms, including currency, demand deposits, time deposits, and plastic money.

The narrowest commonly used measure of money M1 consists of currency (bills, coins, money orders and travelers checks) and current accounts (AmE -checking accounts).

A broader measure M2 includes M1 plus saving accounts.

When the money supply increases,people have more money to spend, and demand for goods and services increases. As demand increases, businesses hire additional workers to increase output. This is an economic growth scenario. But, if output does not keep pace with demand, prices increase. When prices rise continuously, inflation results. This tends to cause problems for people whose incomes do not increase at a rate consistent with inflation.

 

Ex. 1.Match the Russian word combinations in with their English equivalents.

A B
1) спрос на деньги для совершения сделок a) forgone interest
2) спрос на деньги для непредвиденных расходов b) cash receipts from sales
3) спекуляционный спрос на деньги c) transactions demand for money
4) планируемые расходы d) to keep pace with smth
5) упущенные проценты e) withdrawal penalties
6) несение убытков в результате отвлечения капитала f) to increase at a rate consistent with inflation
7) денежные поступления от продаж g) the speculative demand
8) финансовые активы, приносящие доход h) interest-bearing financial assets
9) альтернативные издержки от хранения денег i) ceteris paribus
10) при прочих равных условиях j) predictable expenses
11) взаимные фонды денежного рынка k) time deposits
12) возрастать на уровне, соответствующему уровню инфляции; l) the opportunity cost of holding money
13) поспевать за чем-либо m) the precautionary demand
14) срочные вклады n) money market mutual funds

 



 

Ex. 2.Match the kind of demand for money in A with the stock of money people hold B and the definitions that follow.

A B
1) The transactions demand for money a) “betting money”
2) The precautionary demand for money b) “walking around money”
3) The speculative demand for money c) “mattress money”

 

1. The stock of money people hold to pay unpredictable expenses.

2. The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other non-money financial assets.

3. The stock of money people hold to pay everyday predictable expenses.

 

 

Ex. 3.Choose the correct answer.

1. The stock of money people hold to pay everyday predictable expenses is the:

a. transactions demand for holding money.

b. precautionary demand for holding money.

c. speculative demand for holding money.

d. store of value demand for holding money.

2. The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmoney financial assets is the:

a. unit-of-account motive for holding money.

b. precautionary motive for holding money.

c. speculative motive for holding money.

d. transactions motive for holding money.

3. Which of the following statements is true?

a. The speculative demand for money at possible interest rates gives the demand for money curve its upward slope.

b. There is an inverse relationship between the quantity of money demanded and the interest rate.

c. According to the quantity theory of money, any change in the money supply will have no effect on the price level.

d. All of the above.

 

Ex. 4.Discuss the following questions with your parner.

1. Why do people hold (demand) currency and checkable deposits (M1), rather than putting their money to work in stocks, bonds, real estate, or other nonmoney forms of wealth?

2. What’s the main reason for having ‘walking around money’?

3. What are the consequences of lacking cash?

4. What is the precautionary demand for money based on?

5. What do precautionary balances help to avoid?

6. What is the speculative demand for money held for?

7. Why do people prefer to invest in stocks and bonds when the interest rate is high?

8. What happens to the opportunity cost of holding money when the interest rate falls?

9. What does a demand for money curve represent?

10. What does the money supply of the U.S. consist of?

11. What measures can be taken to regulate the money supply?

12. What may happen if output does not keep pace with demand?

 

Read the text and compare the macroeconomic theories of different schools of economic thought. Explain the difference between the Keynesian and the monetarist views on how an increase in the money supply causes inflation. Note the similarity between the classical and the monetarist schools.

The dominant school of economic thought before the Great Depression was classical economics. The basic theory of the classical economists, introduced by Adam Smith in The Wealth of Nations, was that a market-directed economy will automatically correct itself to full employment. Consequently, there is no need for fiscal policy designed to restore full employment.

A key assumption of classical theory is that, given time to adjust, prices and wages will decrease to ensure the economy operates at full employment. A decrease in the aggregate demand curve causes a temporary surplus, which, in turn, causes businesses to cut prices and, in turn, causes more goods to be purchased because of the real balances effect. As a result, wages adjust downward, and employment rises. Classical economists therefore view the economy as operating in the long run along a vertical aggregate supply curve originating at the full-employment real GDP.





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