Examine the effects on the demand for money in an economy, when the money supply is increasing and more individuals are using credit and debit cards instead of cash to purchase goods and services.

Mark scheme

Marking points from the official mark scheme (Oct/Nov 2018). The mark or mark type is shown in brackets.

1. [12] When the money supply is increasing then this would normally lead to a fall in interest rates. This would not affect active balances based on the transactions/precautionary motives which are interest inelastic. A lower rate of interest would however affect the speculative demand for money which is influenced by an individual's expectations of what is going to happen to the level of interest rates in the future. The overall effect on the speculative demand will depend upon the starting point when the money supply is increased. If interest rates are already very low the demand for money will increase significantly. The use of credit/debit cards will decrease both the transactions and precautionary demand for money.
2. [9-12] L4: for an answer that attempts to evaluate the relative importance of these changes in each case. Some attempt will also be made to discuss the extent of the impact by each change on each type of demand.
3. [7-8] L3: for an answer that analyses the effect of both these changes on each of the three motives for holding money. Answers should develop a logical argument to support their conclusion in each case.
4. [5-6] L2: for an answer that describes the possible effects of these changes on each type of money but does not provide any detailed comment or analysis.
5. [1-4] L1: for an answer that has some basic correct facts but includes irrelevancies and errors of theory.
6. [13] Quantitative Easing takes place when governments create money to purchase long term securities from banks or the non-bank public. This will cause the price of bonds to rise and cause downward pressure on interest rates. Also due to a fall in interest rates plus negative expectations, this is likely to depreciate the value of the currency. Lower interest rates might promote demand pull inflation and lower exchange rates might cause cost push inflation but there are a number of factors which might prevent such changes automatically causing inflation. Existing state of the economy, consumer/investor confidence, exchange rate management might influence the final outcome.
7. [9-13] L4: for an answer that discusses the extent to which a reduction in interest rates combined with a reduction in exchange rates might impact on the price level. A conclusion will be provided.
8. [7-8] L3: for an answer that analyses why the purchase of securities will reduce interest rates and to what extent it will influence the money supply. Also analysis will be used to demonstrate the links between changes in the interest/exchange rate and possible changes in the rate of inflation.
9. [5-6] L2: for an answer that explains how Quantitative Easing will affect interest rates and the exchange rate but this will be descriptive rather than analytical and there will be only a very limited attempt to link changes in these variables to the rate of inflation.
10. [1-4] L1: for an answer that has some basic correct facts but includes irrelevancies and errors of theory.