1 The Baumol-Tobin Model

Here we’ll build some intuition
for the money demand function we’ve been using to characterize the
money market. Suppose you earn
*pY* in nominal income that you want to spend at
constant rate over the course of the next year.One of the ways
generally used to generate demand for money in a model is to posit
that a cash-in-advance constraint must be satisfied ( ie. in order
to spend your income on goods you need to hold cash first). Suppose
wealth can be held in the form of some asset or in the form of
money. For simplicity assume the asset yields return
*r*(the real rate), and money is subject to inflation π and
does not pay interest.

You have to go to the “bank” to transfer wealth from the asset to money. It is costly for you to go to the bank, and it is costly for you to hold money, so the question is how often do you go to the bank, and how much money should you hold.

For example, if you went once
during the year your average money holdings would be
*pY/2*. For N times per year, you would get
*pY/2N*

a.) What’s the opportunity cost of holding real money balances? (Hint:consider the definition of the real rate).

b.) Suppose the nominal cost of
going to the bank is
*pF*. Write down an equation for the total cost of holding
money as a function of
*N*.

c.) You’d like to minimize this
cost function in order to determine how many times per year it is
optimal to visit the bank. In order to do this take a derivative of
your answer in (b.) with respect to
*N* and solve for
*N*.

d.) If nominal rates increase, do you want to visit the bank more or less often?

2 The Current Account

In 2007, the country of Ikonomia has a current account deficit of $1 billion, and a trade deficit of $800 million. Ikonomia’s factors of production located in foreign countries earn $700 million. The country neither gives nor receives unilateral transfers. Ikonomia has a nonreserve financial account surplus of $750 million,and a capital account has a $100 million surplus. Ikonomia’s GDP is $9 billion.

a.) What was the movement in Ikonomia’s net foreign assets during 2007?

b.) Compute the official settlements balance. Based on this value, what was the change in the central bank of Ikonomia’s foreign reserves?

c.) Give the amount of income foreign factors of production earned in Ikonomia during 2007.

d.) Compute NFIA.

e.) Verify that CA+FA+KA=0.

f.) Give the values of GNE, GNI, and GNDI.

1 The Baumol-Tobin Model

Here we’ll build some intuition
for the money demand function we’ve been using to characterize the
money market. Suppose you earn
*pY* in nominal income that you want to spend at
constant rate over the course of the next year.One of the ways
generally used to generate demand for money in a model is to posit
that a cash-in-advance constraint must be satisfied ( ie. in order
to spend your income on goods you need to hold cash first). Suppose
wealth can be held in the form of some asset or in the form of
money. For simplicity assume the asset yields return
*r*(the real rate), and money is subject to inflation π and
does not pay interest.

You have to go to the “bank” to transfer wealth from the asset to money. It is costly for you to go to the bank, and it is costly for you to hold money, so the question is how often do you go to the bank, and how much money should you hold.

For example, if you went once
during the year your average money holdings would be
*pY/2*. For N times per year, you would get
*pY/2N*

a.) What’s the opportunity cost of holding real money balances? (Hint:consider the definition of the real rate).

b.) Suppose the nominal cost of
going to the bank is
*pF*. Write down an equation for the total cost of holding
money as a function of
*N*.

c.) You’d like to minimize this
cost function in order to determine how many times per year it is
optimal to visit the bank. In order to do this take a derivative of
your answer in (b.) with respect to
*N* and solve for
*N*.

d.) If nominal rates increase, do you want to visit the bank more or less often?

2 The Current Account

In 2007, the country of Ikonomia has a current account deficit of $1 billion, and a trade deficit of $800 million. Ikonomia’s factors of production located in foreign countries earn $700 million. The country neither gives nor receives unilateral transfers. Ikonomia has a nonreserve financial account surplus of $750 million,and a capital account has a $100 million surplus. Ikonomia’s GDP is $9 billion.

a.) What was the movement in Ikonomia’s net foreign assets during 2007?

b.) Compute the official settlements balance. Based on this value, what was the change in the central bank of Ikonomia’s foreign reserves?

c.) Give the amount of income foreign factors of production earned in Ikonomia during 2007.

d.) Compute NFIA.

e.) Verify that CA+FA+KA=0.

f.) Give the values of GNE, GNI, and GNDI.

1 The Baumol-Tobin Model

Here we’ll build some intuition
for the money demand function we’ve been using to characterize the
money market. Suppose you earn
*pY* in nominal income that you want to spend at
constant rate over the course of the next year.One of the ways
generally used to generate demand for money in a model is to posit
that a cash-in-advance constraint must be satisfied ( ie. in order
to spend your income on goods you need to hold cash first). Suppose
wealth can be held in the form of some asset or in the form of
money. For simplicity assume the asset yields return
*r*(the real rate), and money is subject to inflation π and
does not pay interest.

You have to go to the “bank” to transfer wealth from the asset to money. It is costly for you to go to the bank, and it is costly for you to hold money, so the question is how often do you go to the bank, and how much money should you hold.

For example, if you went once
during the year your average money holdings would be
*pY/2*. For N times per year, you would get
*pY/2N*

a.) What’s the opportunity cost of holding real money balances? (Hint:consider the definition of the real rate).

b.) Suppose the nominal cost of
going to the bank is
*pF*. Write down an equation for the total cost of holding
money as a function of
*N*.

c.) You’d like to minimize this
cost function in order to determine how many times per year it is
optimal to visit the bank. In order to do this take a derivative of
your answer in (b.) with respect to
*N* and solve for
*N*.

d.) If nominal rates increase, do you want to visit the bank more or less often?

2 The Current Account

In 2007, the country of Ikonomia has a current account deficit of $1 billion, and a trade deficit of $800 million. Ikonomia’s factors of production located in foreign countries earn $700 million. The country neither gives nor receives unilateral transfers. Ikonomia has a nonreserve financial account surplus of $750 million,and a capital account has a $100 million surplus. Ikonomia’s GDP is $9 billion.

a.) What was the movement in Ikonomia’s net foreign assets during 2007?

b.) Compute the official settlements balance. Based on this value, what was the change in the central bank of Ikonomia’s foreign reserves?

c.) Give the amount of income foreign factors of production earned in Ikonomia during 2007.

d.) Compute NFIA.

e.) Verify that CA+FA+KA=0.

f.) Give the values of GNE, GNI, and GNDI.

1 The Baumol-Tobin Model 1 The Baumol-Tobin Model

Here we’ll build some intuition
for the money demand function we’ve been using to characterize the
money market. Suppose you earn
*pY* in nominal income that you want to spend at
constant rate over the course of the next year.One of the ways
generally used to generate demand for money in a model is to posit
that a cash-in-advance constraint must be satisfied ( ie. in order
to spend your income on goods you need to hold cash first). Suppose
wealth can be held in the form of some asset or in the form of
money. For simplicity assume the asset yields return
*r*(the real rate), and money is subject to inflation π and
does not pay interest.
Here we’ll build some intuition
for the money demand function we’ve been using to characterize the
money market. Suppose you earn
*pY* in nominal income that you want to spend at
constant rate over the course of the next year.One of the ways
generally used to generate demand for money in a model is to posit
that a cash-in-advance constraint must be satisfied ( ie. in order
to spend your income on goods you need to hold cash first). Suppose
wealth can be held in the form of some asset or in the form of
money. For simplicity assume the asset yields return
*r*(the real rate), and money is subject to inflation π and
does not pay interest.
*pY*
*r*

You have to go to the “bank” to transfer wealth from the asset to money. It is costly for you to go to the bank, and it is costly for you to hold money, so the question is how often do you go to the bank, and how much money should you hold. You have to go to the “bank” to transfer wealth from the asset to money. It is costly for you to go to the bank, and it is costly for you to hold money, so the question is how often do you go to the bank, and how much money should you hold.

For example, if you went once
during the year your average money holdings would be
*pY/2*. For N times per year, you would get
*pY/2N*
For example, if you went once
during the year your average money holdings would be
*pY/2*. For N times per year, you would get
*pY/2N*
*pY/2*
*pY/2N*

a.) What’s the opportunity cost of holding real money balances? (Hint:consider the definition of the real rate). a.) What’s the opportunity cost of holding real money balances? (Hint:consider the definition of the real rate).

b.) Suppose the nominal cost of
going to the bank is
*pF*. Write down an equation for the total cost of holding
money as a function of
*N*.
b.) Suppose the nominal cost of
going to the bank is
*pF*. Write down an equation for the total cost of holding
money as a function of
*N*.
*pF*
*N*

c.) You’d like to minimize this
cost function in order to determine how many times per year it is
optimal to visit the bank. In order to do this take a derivative of
your answer in (b.) with respect to
*N* and solve for
*N*.
c.) You’d like to minimize this
cost function in order to determine how many times per year it is
optimal to visit the bank. In order to do this take a derivative of
your answer in (b.) with respect to
*N* and solve for
*N*.
*N*
*N*

d.) If nominal rates increase, do you want to visit the bank more or less often? d.) If nominal rates increase, do you want to visit the bank more or less often?

2 The Current Account 2 The Current Account

In 2007, the country of Ikonomia has a current account deficit of $1 billion, and a trade deficit of $800 million. Ikonomia’s factors of production located in foreign countries earn $700 million. The country neither gives nor receives unilateral transfers. Ikonomia has a nonreserve financial account surplus of $750 million,and a capital account has a $100 million surplus. Ikonomia’s GDP is $9 billion. In 2007, the country of Ikonomia has a current account deficit of $1 billion, and a trade deficit of $800 million. Ikonomia’s factors of production located in foreign countries earn $700 million. The country neither gives nor receives unilateral transfers. Ikonomia has a nonreserve financial account surplus of $750 million,and a capital account has a $100 million surplus. Ikonomia’s GDP is $9 billion.

a.) What was the movement in Ikonomia’s net foreign assets during 2007? a.) What was the movement in Ikonomia’s net foreign assets during 2007?

b.) Compute the official settlements balance. Based on this value, what was the change in the central bank of Ikonomia’s foreign reserves? b.) Compute the official settlements balance. Based on this value, what was the change in the central bank of Ikonomia’s foreign reserves?

c.) Give the amount of income foreign factors of production earned in Ikonomia during 2007. c.) Give the amount of income foreign factors of production earned in Ikonomia during 2007.

d.) Compute NFIA. d.) Compute NFIA.

e.) Verify that CA+FA+KA=0. e.) Verify that CA+FA+KA=0.

f.) Give the values of GNE, GNI, and GNDI. f.) Give the values of GNE, GNI, and GNDI.

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