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Intermediate Macroeconomics


7. Market for Money


We begin with a model of money demand based on consumer utility maximizing decisions in an environment that includes cash goods and credit goods. We use optimal decisions for cash versus credit goods to derive a theory of money demand. We combine this with the money supply determined by the central bank to describe and illustrate equilibrium outcomes in the market for money.


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Credit vs Cash Goods

We begin by describing a framework for credit versus cash goods. Cash goods are goods for which consumers must make cash payments, and credit goods can be purchased with payments involving financial services, such a credit card. Consumers gain utility from both goods, both are normal goods, and these two types of goods are imperfect substitutes for one another. Consumers pay an explicit cost for using financial services, which is revenue for financial institutions. We conclude this Pencast suggesting an upward sloping supply function for credit services, such that credit services depend positively on the per-unit fee for financial services. [Play Pencast]


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Demand for Credit Goods

Consumers face an opportunity cost to purchasing cash goods. When cash payments are made, this financial asset cannot earn interest income. Since credit goods are not immediately paid for out of cash on hand, consumers are able to temporarily earn interest on financial assets which will be later used for means of payment for credit goods. However, there is an explicit cost that consumers pay to financial institutions for credit services. We consider these explicit and implicit costs and derive a theory for consumers' utility maximizing behavior for cash versus credit goods. We derive a demand function for credit goods which depends negatively on the fee for credit services and positively on the nominal interest rate. [Play Pencast]


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Interest Rate: Shift in Demand for Credit Good

We use utility maximizing behavior of consumers to describe and illustrate how a change in the interest rate shifts the demand for credit goods. We find an increase in the interest rate causes an increase (rightward shift) in demand for credit goods. [Play Pencast]


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Income: Shift in Demand for Credit Good

We use utility maximizing behavior of consumers to describe and illustrate how a change in income shifts the demand for credit goods. We find an increase in income causes an increase (rightward shift) in demand for credit goods. [Play Pencast]


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Money Demand

We derive a theory for money demand based on consumers' utility maximizing demand for cash versus credit goods. We find that money demand depends positively on real GDP and price level and negatively on the nominal interest rate. [Play Pencast]


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Fisher Equation

We derive the Fisher equation, a theory for the relationship between the nominal interest rate, the real interest rate, and the rate of inflation. [Play Pencast]


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