Q.3 Explain why you would be more or... [FREE SOLUTION]

Chapter 5: Q.3 (page 163)

Explain why you would be more or less willing to buy gold under the following circumstances: a. Gold again becomes acceptable as a medium of exchange.
b. Prices in the gold market become more volatile.
c. You expect inflation to rise, and gold prices tend to move with the aggregate price level.
d. You expect interest rates to rise

Short Answer

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Part (a) If gold is accepted as a medium of exchange, people will be more ready to buy it.

Part (b) If the gold market becomes more volatile, people will be less likely to buy it.

Part (c) If one anticipates inflation to grow and the gold price to climb with it, one will be more likely to purchase gold.

Part (d) If interest rates are predicted to rise, people will be more ready to buy gold.

Step by step solution

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

Explanation to part (a)

If gold is recognized as a means of exchange, people will be more likely to buy it since it will improve liquidity, and investors prefer to invest in liquid assets.

As a result, if gold is accepted as a medium of exchange, people will be more ready to buy it.

Explanation to part (b)

If the gold market becomes more volatile, it will raise the risk for investors, and they will avoid investing in gold because no one wants to engage in a dangerous market.

As a result, if the gold market becomes more volatile, people will be less likely to buy it.

Explanation to part (c)

If one expects inflation to grow and the price of gold to climb with it, one should consider investing in gold. By purchasing gold now and selling it at a higher price later, investors can make more money.

As a result, if one anticipates inflation to grow and the gold price to climb with it, one will be more likely to purchase gold.

Explanation to part (d)

If one believes that interest rates will rise, he will be more willing to buy gold since bonds will become more expensive in comparison to gold, and the investor would prefer to invest where he will earn a higher return.

As a result, if interest rates are predicted to rise, people will be more ready to buy gold.