Assignment 3 - Account Towards Final Grade

Economics for Business Studies Assignment 3 This assignment is due by 5pm, Apr 17 (F). Please submit your answer via Blackboard. Late submission will be accepted with a deduction in points. Section I: Multiple Choice Questions Identify the letter of the choice that best completes the statement or answers the question. 1. You receive money as payment for babysitting your neighbors' children. This best illustrates which function of money? a. medium of exchange b. unit of account c. store of value d. liquidity 2. When the Fed purchases $200 worth of government bonds from the public, the US money supply eventually increases by a. more than $200. b. exactly $200. c. less than $200. d. None of the above are correct. 3. a. b. c. d. If the money multiplier is 2 and the Fed wants to increase money supply by $900,000, it could buy $300,000 worth of bonds. buy $450,000 worth of bonds. sell $300,000 worth of bonds. sell $450,000 worth of bonds. 4. a. b. c. d. The discount rate is the interest rate that banks charge one another for loans. banks charge the Fed for loans. the Fed charges banks for loans. the Fed charges Congress for loans. 5. In a fractional-reserve banking system with no excess reserves and no currency holdings, if the central bank buys $100 million worth of bonds, a. reserves and the money supply increase by less than $100 million. b. reserves increase by $100 million and the money supply increases by $100 million. c. reserves increase by $100 million and the money supply increases by more than $100 million. d. both reserves and the money supply increase by more than $100 million. 1 of 3 6. If the federal funds rate were below the level the Federal Reserve had targeted, the Fed could move the rate back towards its target by a. buying bonds. This buying would increase the money supply. b. buying bonds. This buying would reduce the money supply. c. selling bonds. This selling would increase the money supply. d. selling bonds. This selling would reduce the money supply. 7. a. b. c. d. Which of the following statements is correct? M2 is both larger and more liquid than M1. M2 is both smaller and less liquid than M1. M2 is larger than M1 but less liquid than M1. None of the above. 8. a. b. c. d. According to the classical dichotomy, which of the following is affected by monetary factors? nominal wages the price level nominal GDP All of the above are correct. 9. a. b. c. d. If M = 10,000, P = 2, and Y = 20,000, then velocity = 4. Velocity will rise if money changes hands more frequently. 4. Velocity will rise if money changes hands less frequently. 8. Velocity will rise if money changes hands more frequently. 8. Velocity will rise if money changes hands less frequently. 10. a. b. c. d. According to the quantity equation, if money supply increases by 5 percent, then nominal and real GDP would rise by 5 percent. nominal GDP would rise by 5 percent; real GDP would be unchanged. nominal GDP would be unchanged; real GDP would rise by 5 percent. it is uncertain if nominal GDP or real GDP would change. 11. According to the classical dichotomy, which of the following is influenced by monetary factors? a. real GDP b. unemployment c. nominal interest rates d. All of the above are correct. 12. Which of the following is correct? a. The classical dichotomy separates real and nominal variables. b. Monetary neutrality states that changes in the money supply do not change real variables. c. When studying long-run changes in the economy, the neutrality of money offers a good description of how the world works. d. All of the above are correct. 13. a. b. c. d. A bank’s reserve ratio is 10 percent. It has $5,000 in deposits. Its reserves amount to $50. $500. $4,500. $4,950. 2 of 3 14. Suppose the banking system currently has $400 billion in reserves, the reserve requirement is 8 percent, and excess reserves amount to $5 billion. What is the level of deposits? a. $5,000 billion b. $4,937.5 billion c. $5,062.5 billion d. $4,995 billion 15. A bank has an 8 percent reserve requirement, $10,000 in deposits, and has loaned out all it can given the reserve requirement. a. It has $80 in reserves and $9,920 in loans. b. It has $800 in reserves and $9,200 in loans. c. It has $1,250 in reserves and $8,750 in loans. d. None of the above is correct. Section II: Short Questions 1. Money and price level Using separate graphs, demonstrate what happens to the money supply, money demand, the value of money, and the price level if: a. the Fed increases the money supply. If the Fed decides to increase the money supply, the money supply curve will shift to the right from S1 to S2. This shift will cause the value of money to fall thus increases price level. Money demand curve will stay the same. b. people decide to demand less money at each value of money. If people decide to demand less money, the money demand curve will shift to the left from D1 to D2. The decrease in money demand will cause the value of money to fall thus increases price level. Money supply curve will stay the same. 3 of 3 2. Quantity Equation Consider a simple economy that produces only cakes. The table below contains information on the economy’s money supply, velocity of money, price level and output. a. Fill in the missing values in the table. Year 2017 2018 Quantity of Money (dollars) 400 404 Velocity of Money 10 10 Price Level (dollars) 5 5.05 Output (cakes) 800 800 Nominal GDP (dollars) 4000 4040 b. Find the growth rate of money supply from 2017 to 2018. Is it equal to inflation rate? Money supply growth rate = 404-400/400 x 100% = 1% Inflation rate = 5-0.5/5 x 100% = 1% Yes, the growth rate of money supply is equal to inflation rate. The increase in the quantity of money is reflected entirely in a rising price level. c. If your answer to part (b) is yes, do you expect an equality again in the following year? If the velocity of money and real output are constant, changes in the money supply cause proportionate changes in the price level. So, equality can be reached in the following year under this circumstance (This is based on the quantity of money theory M x V = P x Y). 3. Bank Run a. Fill in the blanks: During a bank run, depositors decide to hold (i)more cash and banks decide to hold (ii)more reserves relative to deposits. b. Do you expect the interest rate to change as a result? Briefly explain. Yes, interest rate will increase to encourage people to deposit their cash in banks because the reserve bank holds might not cover all withdrawals demanded from depositors. In fact, banks might end up selling some of their assets to cover the withdrawals from depositors. So, to gain reserves bank might increase interest rate to attract more deposits. 4 of 3 4. Credit creation The Central Bank of Island Cool conducts a $100 million open-market purchase of government bonds. If the required reserve ratio is 10%, what is the largest possible increase in the money supply that could result? What is the smallest possible increase? Explain briefly. The money multiplier could be as high as 1/0.10 = 10 since the required reserve ratio is 10%. If banks hold no excess reserves and people do not keep some additional currency, the maximum increase in the money supply from a $100 million open-market purchase is $1000 million (or $1 billion). The smallest possible increase is $100 million if all of the money is held by banks as excess reserves. 5 of 3