Velocity and Money Demand
Assume, based on income, a person spends $30 a day on goods and services.
The person has a savings account at a bank. This savings account is not money since the person cannot use it as a medium of exchange but it does pay a “market rate” of interest. A “market rate” of interest is the current interest rate in the market place and is higher than what a checking account may pay (often, checking accounts pay no interest). To be able to buy stuff, the person must visit the bank and transfer money from their savings account to checking or into currency. You can think that the person deposits a paycheck into the savings account every payday to replenish the savings balance.
1) Assume when the person goes to the bank, they withdrawal $600 from savings (putting the money into checking or keeping it as cash).
What is the person’s annual consumption? ________
How many days will their money last? ________
How many times will the person visit the bank every year? ________
What is velocity? (hint: it’s the same as the number of trips to the bank per year) _____
2) The person changes their withdrawal to $300 each visit. $30 per day spending stays the same.
What is the person’s annual consumption? ________
How many days will their money last? ________
Compared to case 1, how does this change the quantity of savings? __________
How many times will the person visit the bank every year? ________
What is velocity? _____
What is the relationship between velocity and how much money people carry (demand):
3) The person wants to reduce velocity to 12. Daily spending stays the same.
What is the person’s annual consumption? ________
How many times will the person visit the bank every year? ________
How many days must their money withdrawal last? ________
How much money will the person need to withdrawal? ________
How does this change the quantity of savings? _________
Why would someone want to make more frequent trips to the bank?
Why would someone want to make less frequent trips to the bank?
Money Equilibrium Review
1) Describe what happens in the market for money when there’s a money surplus:
2) Describe what happens in the market for money when there’s a money shortage: