In case the question requires us to explain the four factors that determine the demand for money according to the portfolio theory. Concept Introduction: Portfolio theory: American economist James Tobin justified that rational individuals will keep portfolio of consisting of money (cash) and bond rather than keeping wealth either in money (cash) or bond. According to Tobin, people are in general risk averse. Human behaviour demonstrates risk aversion. This implies that, they have a preference towards lesser risk at a given rate of return . In the Keynesian analysis, the wealth of a person is either in the form of all money or all bonds depending on his expectation of the future rate of interest. According to Tobin, faced with various safe and risky assets, individuals prefer to diversify their portfolio by sharing their wealth in a balanced combination of safe and risky assets. According to him, an investor is confronted with a dilemma of what quantity of his portfolio of assets should be in the form of money (without any interest) and interest-earning bonds. Portfolio theory highlights the function of money as a store of value. Money presents a blend of risk and return as compared other assets which are less liquid than money — such as bonds. According the money portfolio theory, demand function of money is expressed as: (M/P) d = f(r s , r b , p e , W) Where r s = the expected real return on stock, r b = the expected real return on bonds, p e = the expected inflation rate and W= real wealth. The four factors that determine the demand for money are: Expected real return on stocks (r s ) Expected real return on bonds (r b ) Expected inflation rate (p e ) Real wealth (W)

Question

Want to see the full answer?

Answer 1

Question

Chapter 22, Problem 14Q

To determine

In case the question requires us to explain the four factors that determine the demand for money according to the portfolio theory.

Concept Introduction:

Portfolio theory: American economist James Tobin justified that rational individuals will keep portfolio of consisting of money (cash) and bond rather than keeping wealth either in money (cash) or bond. According to Tobin, people are in general risk averse. Human behaviour demonstrates risk aversion. This implies that, they have a preference towards lesser risk at a given rate of return. In the Keynesian analysis, the wealth of a person is either in the form of all money or all bonds depending on his expectation of the future rate of interest. According to Tobin, faced with various safe and risky assets, individuals prefer to diversify their portfolio by sharing their wealth in a balanced combination of safe and risky assets. According to him, an investor is confronted with a dilemma of what quantity of his portfolio of assets should be in the form of money (without any interest) and interest-earning bonds. Portfolio theory highlights the function of money as a store of value. Money presents a blend of risk and return as compared other assets which are less liquid than money — such as bonds.

According the money portfolio theory, demand function of money is expressed as:

(M/P)_d = f(r_s, r_b, p_e, W)

Where r_s = the expected real return on stock, r_b = the expected real return on bonds, p_e = the expected inflation rate and W= real wealth.

The four factors that determine the demand for money are:

Expected real return on stocks (r_s)

Expected real return on bonds (r_b)

Expected inflation rate (p_e)

Real wealth (W)

Expert Solution & Answer

Want to see the full answer?

Check out a sample textbook solution

See solution

Students have asked these similar questions

China is a leader in international trade, has one of the highest GDPs, and currently holds the largest foreign exchange reserve in the world. Is it fair for China to fix its currency by undervaluing it on the market? How does keeping its currency undervalued give it a favorable position in international trade? What about from the viewpoints of international companies and consumers?

Explain the requirements of the states that have enacted legislation to protect taxpayers from predatory tax return preparers and tax refund advances.

Responsd to Luis Rodriguez 1800 tons of pomegranates a year is a lot of sweetness! So, you can get 71 Afghanis for $1? How cool. Does that mean you can buy a lot of stuff in Afghanistan for only $1? How do you know that your purchasing power in Afghanistan is stronger than in the United States? Yes, with an exchange rate of 71 Afghan Afghani for 1 US dollar, you can buy many things in Afghanistan for just $1. However, purchasing power isn't solely determined by the exchange rate. It also depends on the cost of goods and services in each country. For example, if a meal in Afghanistan costs 200 Afghanis, you would need about $2.82 to buy that meal in US dollars (since 200 Afghanis divided by 71 Afghanis per dollar equals approximately $2.82). So, while the exchange rate allows you to get more Afghanis for your dollars, you also need to consider how much things cost in Afghanistan. Now that the world seems to like Afghani stuff and is buying more of it, does that mean your…