Average: 2 Attempts: 1. The opportunity cost of holding money Suppose you\'ve ju

Question

Average: 2 Attempts: 1. The opportunity cost of holding money Suppose you've just inherited $10,000 from a relative. You're trying to decide whether to put the $10,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond The opportunity cost of holding the inheritance as money depends on the interest rate on the bond. For each of the interest rates in the following table, compute the opportunity cost of holding the $10,000 as money. Opportunity Cost (Dollars per year) Interest Rate on Government Bond (Percent) 8 What does the previous analysis suggest about the market for money? The quantity of money demanded increases as the interest rate rises The quantity of money demanded decreases as the interest rate rises. The supply of money is independent of the interest rate.

Explanation / Answer

(1)

(a)

(b) Quantity of money demanded decreases as interest rate rises.

(Reason: As interest rate rises, opportunity cost of holding money, which is the interest income foregone, increases, so people want to hold less money (lowering demand for money) and invest more in interest bearing assets).

NOTE: As per Chegg answering guidelines, first question is answered.

Interest rate on Government Bond (%) Opportunity cost ($) 6 10,000 x 6% = 600 8 10,000 x 8% = 800

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