Quizzol

QUESTION:

Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the $5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond.

The opportunity cost of holding the inheritance as money depends on the interest rate on the bond.

For each of the interest rates in the following table, compute the opportunity cost of holding the $5,000 as money.

Interest Rate on Government Bond	Opportunity Cost
(Percent)	(Dollars per year)
9
6

What does the previous analysis suggest about the market for money?

The quantity of money demanded decreases as the interest rate falls.

The quantity of money demanded increases as the interest rate falls.

The supply of money is independent of the interest rate.

ANSWER:

The opportunity cost of holding the inheritance as money depends on the interest rate on the bond.

For each of the interest rates in the following table, compute the opportunity cost of holding the $5,000 as money.

Interest Rate on Government Bond	Opportunity Cost
(Percent)	(Dollars per year)
9	450.00
6	300.00

Points:

1 / 1

If you invested $5,000 in a government bond that pays 9% per year, you would receive 9% of $5,000, or $450, in interest payments. Therefore, the opportunity cost of keeping your money in cash would be $450 per year.

If the bond pays 6% per year, you would receive 6% of $5,000, or $300, in interest payments. Therefore, the opportunity cost of keeping your money in cash would be $300 per year.

Note that as the interest rate falls, the amount of interest you can receive by investing in the government bond decreases. Therefore, the opportunity cost of holding your inheritance money in a non-interest-bearing account decreases.