Suppose a Family Is Holding $1000 in Its Checking Account

question 103

Multiple Choice

Suppose a family is holding $1000 in its checking account for normal transactions, $500 in cash for emergencies, and $1500 as a store of value when the interest rate is 4 percent. If the interest rate rises to 10 percent, which of the following patterns of holding money would be most likely and why?

• A) Transactions demand-$1000; Precautionary demand-$350; Asset demand-$500, because the opportunity cost of holding money has increased. The reduction money balances held as an asset is greatest because interest-bearing assets are much more attractive when interest rates are higher.
• B) Transactions demand-$500; Precautionary demand-$500; Asset demand-$1400, because the opportunity cost of holding money balances has risen. The reduction in money balances held for transaction purposes falls the most because people start using credit cards more when the opportunity cost of holding money increases.
• C) Transactions demand-$1000; Precautionary demand-$500; Asset demand-$500, because only the asset demand is responsive to changes in the interest rate.
• D) Transactions demand-$800; Precautionary demand-$600; Asset demand-$1500, because people can economize on their money balances for making transactions, but the possibility of an emergency increases with the interest rate. People will also expect rates to go higher, so they will hold money as an asset until the rates increase further.

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Definitions:

Lifestyles

The way in which a person or group lives, including patterns of social relations, consumption, entertainment, and dress.

Supply Side

Economic theory emphasizing the importance of policies that affect the production and supply in an economy, including investment in capital and labor efficiency.

Market Definition

Involves identifying the boundaries of a market both in terms of the product or service and the geographic area in which it competes.

Primary Industry

The sector of an economy involving the extraction and production of raw materials, such as farming, mining, and forestry.