Question

Explain how each of the following would affect the quantity of money demanded. Does the change cause a movement along the money demand curve or a shift of the money demand curve?

a. Short-term interest rates rise from 5% to 30%.

b. All prices fall by 10%.

c. New wireless technology automatically charges supermarket purchases to credit cards, eliminating the need to stop at the cash register.

d. In order to avoid paying a sharp increase in taxes, residents of Laguria shift their assets into overseas bank accounts. These accounts are harder for tax authorities to trace but also harder for their owners to tap and convert funds into cash.

Short answer

1. This will reduce money demand and cause a movement along the demand curve.
2. The price rise will reduce the amount of money demanded causing a leftward shift in the demand for money curve.
3. The purchase of credit cards will decrease the money demand and cause a leftward shift in the demand for money curve.
4. The shifting of assets to avoid higher taxes will reduce the demand for money, thereby shifting the demand curve towards the left.

Step-by-step solution

Rise in interest rates

The demand for money establishes a negative relationship between interest rates and the quantity of money demanded in the economy. Therefore, if interest rates decrease, the quantity of money demand increases, and if the interest rates increase, the quantity of money demand decreases. These increases and decreases change the equilibrium level by causing a movement along the demand curve.

If the interest rate increases from 5-30%, the quantity of money in the economy will reduce, causing an upward movement along the money demand curve.

Fall in prices

The price level and the amount of money demanded to have a positive relationship with one another. This positive relationship is also proportional. Thus, any increase or decrease in the economy's price levels will bring out a proportional increase or decrease in the amount of money demanded in the economy. Inflation causes people to hold more money to buy the same quantity of goods and services.

Therefore a 10% decrease in the price level will cause a decrease in theamount of money demandedin the economy, shifting the initial demand curve towards the left.

Changes in technology

A change in the technology which enables customers to get charged through credit cards without much hustle will reduce their demand for money since they will feel they do not need to carry cash all the time.

This reduced demand for money due to changes in technology will cause a leftward shift in the demand curve.

Change of assets into accounts 

The people of Liguria are avoiding paying taxes here; thus, they are ready to convert their assets into overseas accounts, which even reduces their liquidity. The citizens are still willing to do so since they do not want to pay high taxes. Thus,we can interpret that increased taxes reduces the demand for money, causing a shift in the demand curve towards the left.