Economics Unit 5

a. What group determines monetary policy? b. How many members serve in this group? c. Who always serves in this group? d. Who sometimes serves in this group? Explain.

a. The Federal Open Market Committee b. 12 members c. Members of the board of governors and the new york federal reserve bank president. d. 4 of the other 11 federal reserve bank presidents will serve. they all rotate their time as being a part of the FOMC

What is the present value of $100 realized two years from now if the interest rate is 10%? a. $80 b. $83 c. $90 d. $100 e. $11

b. $83 because 100/(1+.1)squared because it is after 2 years

Which of the following will increase the demand for loanable funds? a. a federal government budget surplus b. an increase in perceived business opportunities c. a decrease in the interest rate d. positive capital inflows e. decreased private saving rates

b. an increase in perceived business opportunities

A financial intermediary that provides liquid financial assets in the form of deposits to lenders and uses their funds to finance the illiquid investment spending needs of borrowers is called a a. mutual fund. b. bank. c. corporation. d. pension fund. e. life insurance company

b. bank

What will happen to the money supply and the equilibrium interest rate if the Federal Reserve sells Treasury securities? Money supply Equilibrium interest rate a. increase increase b. decrease increase c. increase decrease d. decrease decrease e. decrease no change

b. decrease increase

If the interest rate is zero, then the present value of a dollar received at the end of the year is a. more than $1. b. equal to $1. c. less than $1. d. zero. e. infinite.

b. equal to $1

Rank the following assets from the lowest level to the highest level of (i) transaction costs, (ii) risk (iii) liquidity. Ties are acceptable for items that have indistinguishable rankings. a. a bank deposit with a guaranteed interest rate b. a share of a highly diversified mutual fund, which can be quickly sold c. a share of the family business, which can be sold only if you find a buyer and all other family members agree to the sale

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What are the four basic functions of the Federal Reserve System and what part of the system is responsible for each?

1. Provide Financial Services- The 12 regional Federal Reserve Banks provide financial services to depository institutions such as banks and other large institutions, including the U.S. government. 2. Supervise and Regulate Banking Institutions-The regional Federal Reserve Banks examine and regulate commercial banks in their district. The Board of Governors also engages in regulation and supervision of financial institutions. 3. Maintain the Stability of the Financial System- As part of this function, Federal Reserve banks provide liquidity to financial institutions to ensure their safety and soundness. 4. Conduct Monetary Policy-The Federal Reserve uses the tools of monetary policy to prevent or address extreme macroeconomic fluctuations in the U.S. economy.

Identify and describe the three tasks of a well-functioning financial system.

1. decrease transaction costs-facilitates investment spending by allowing companies to borrow large sums of money without incurring large transaction costs 2.Decrease Risk-helps people reduce their exposure to risk so they are more willing to participate in investment spending in the face of uncertainty about the economy. 3.Provide Liquidity-allow a fast low-cost conversion of assets into cash

List and describe the four most important types of financial intermediaries.

A financial intermediary is an institution that transforms funds from many individuals into financial assets. the 4 types are 1. Mutual Funds-creates a stock portfolio by buying and holding shares in companies and then selling shares of the stock portfolio to various investors. 2. Pension Funds-nonprofit institutions that collect the savings of their members and invest them in a wide variety of assets, providing their members with income when they retire 3.Life Insurance Companies-Life Insurance is a contract between an insurance policy holder and an insurer/assurer, where the insurer promises to pay a designated beneficiary a sum of money in exchange for a premium, upon the death of an insured person. 4. Bank-provides liquid financial assets in the form of deposits to lenders and uses their funds to finance the illiquid investment spending needs of borrowers

a. What does the Board of Governors of the Federal Reserve System do? b. How many members serve on the group? c. Who appoints members? d. How long do members serve? e. Why do they serve a term of this length? f. How long does the chair serve?

A. They make monetary policy b. 7 c. the president and they are approved by the senate d. 14 years e. to avoid short-term political pressure f. the chair serves 4 years but they can be reappointed

a. The U.S. dollar derives its value from what? That is, what "backs" U.S. currency? b. What is the term used to describe the type of money used in the United States today? c. What other two types of money have been used throughout history? Define each.

A. it derives it's value simply from its official status because it is fiat money. B. fiat money . Commodity money which is money that has intrinsic value in other uses and Commodity-Backed Money which is money that has no intrinsic value but is guaranteed by a promise that it can be converted into valuable goods.

Although most bank accounts pay some interest, depositors can get a higher interest rate by buying a certificate of deposit, or CD. The difference between a CD and a checking account is that the depositor pays a penalty for withdrawing the money before the CD comes due—a period of months or even years. Small CDs are counted in M2, but not in M1. Explain why they are not part of M1.

It isn't a part of M1 because it isn't easily converted into cash

If the Fed purchases U.S. Treasury bills from a commercial bank, what happens to bank reserves and the money supply? Bank reserves Money supply a. increase decrease b. increase increase c. decrease decrease d. decrease increase e. increase no change

b. increase and increase because when the fed purchases treasury bills it pays money and hence increases the money supply in the market. as the money supply increases so do the reserves

Which of the following is the best example of using money as a store of value? a. A customer pays in advance for $10 worth of gasoline at a gas station. b. A babysitter puts her earnings in a dresser drawer while she saves to buy a bicycle. c. Travelers buy meals on board an airline flight. d. Foreign visitors to the United States convert their currency to dollars at the airport. e. You use $1 bills to purchase soda from a vending machine.

b. it is being stored for future consumption

The real interest rate equals the a. nominal interest rate plus the inflation rate. b. nominal interest rate minus the inflation rate. c. nominal interest rate divided by the inflation rate. d. nominal interest rate times the inflation rate. e. federal funds rate.

b. nominal interest rate minus the inflation rate

Which of the following is NOT a role of the Federal Reserve System? a. controlling bank reserves b. printing currency (Federal Reserve notes) c. carrying out monetary policy d. supervising and regulating banks e. holding reserves for commercial banks

b. printing currency (federal reserve notes) this is done by the U.S. Treasury

If the interest rate is 10%, the present value of $1 paid to you one year from now is a. $0. b. $0.89. c. $0.91. d. $1. e. more than $1.

c. $0.91

Which of the following changes would be the most likely to reduce the size of the money multiplier? a. a decrease in the required reserve ratio b. a decrease in excess reserves c. an increase in cash holding by consumers d. a decrease in bank runs e. an increase in deposit insurance

c. an increase in cash holding by consumers because their is less money in circulation

Which of the following will increase the supply of loanable funds? a. an increase in perceived business opportunities b. decreased government borrowing c. an increased private saving rate d. an increase in the expected inflation rate e. a decrease in capital inflows

c. an increased private saving rate

When banks make loans to each other, they charge the a. prime rate. b. discount rate. c. federal funds rate. d. CD rate. e. mortgage rate.

c. federal funds rate. this is the rate at which things are borrowed and lent

When you decide you want "$10 worth" of a product, money is serving which role(s)? I. medium of exchange II. store of value III. unit of account a. I only b. II only c. III only d. I and II only e. I, II, and III

c. lll only

A business will decide whether or not to borrow money to finance a project based on a comparison of the interest rate with the from its project. a. expected revenue b. profit c. rate of return d. cost generated e. demand generated

c. rate of return

Draw a correctly labeled graph showing equilibrium in the money market. Select an interest rate below the equilibrium interest rate and explain what occurs in the market at that interest rate and how the market will eventually return to equilibrium.

money supply intersects money demanded. if the interest rate is below equilibrium then the quantity of money demanded will increase and exceed the actual amount of money available causing interest rates to rise until it returns to equilibrium.

Describe the balance sheet effect. Describe the vicious cycle of de leveraging. Why is it necessary for the government to step in to halt a vicious cycle of de leveraging?

the balance sheet effect is when a company tries to sell a large amount of an asset for a low price which makes any other shares in the asset drop in value as well.

Why did the creation of the Federal Reserve fail to prevent the bank runs of the Great Depression? What measures did stop the bank runs?

the banks were required to keep money but everyone still had to rush for it. Deposit insurance stopped the runs because people knew their money was insured by the gov.

.What contributed to the creation of the Federal Reserve System?

the panic of 1907

Explain what is wrong with the following statement: "Savings and investment spending may not be equal in the economy as a whole in equilibrium because when the interest rate rises, households will want to save more money than businesses will want to invest."

when the interest rate rises there will be a new equilibrium point and that will be self corrected

Take the example of Silas depositing his $1,000 in cash into First Street Bank and assume that the required reserve ratio is 10%. But now assume that each recipient of a bank loan keeps half the loan in cash and deposits the rest. Trace out the resulting expansion in the money supply through at least three rounds of deposits.

1000 is deposited and 100 is kept in reserves so 900 is loaned out. silas keeps 450 worth and then deposits an additional 450. 45 of this 450 is kept in reserves and 405 is loaned out. 202.5 of this 405 is kept and the other 202.5 is deposited. 20.25 of this 202.5 is kept in reserves and the other 182 is loaned out

Assume that any money lent by a bank is deposited back in the banking system as a checkable deposit and that the reserve ratio is 10%. Trace out the effects of a $100 million open -market purchase of U.S. Treasury bills by the Fed on the value of checkable bank deposits. What is the size of the money multiplier?

100million to start with. 10 million is kept in reserves while 90 million is lent out. this 90 million is deposited and an additional 9 million is placed in reserves while 81 million is deposited and the cycle continues. the money multiplier is 1 divided by the reserve ratio of .1 which equals 10.

Assume that total reserves are equal to $200 and total checkable bank deposits are equal to $1,000. Also assume that the public does not hold any currency and banks hold no excess reserves. Now suppose that the required reserve ratio falls from 20% to 10%. Trace out how this leads to an expansion in bank deposits.

200 is currently in the reserves as 20% of bank deposits. If the reserve ratio falls to 10% only 100 would have to stay in the reserves. This extra 100 can now be lent out and will lead to an increase in spending and therefore deposits

Consider the three hypothetical projects shown in Table 24.1. This time, however, suppose that the interest rate is only 2%. a. Calculate the net present values of the three projects. Which one is now preferred? b. Explain why the preferred choice is different with a 2% interest rate from with a 10% interest rate.

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A con artist has a great idea: he'll open a bank without investing any capital and lend all the deposits at high interest rates to real estate developers. If the real estate market booms, the loans will be repaid and he'll make high profits. If the real estate market goes bust, the loans won't be repaid and the bank will fail—but he will not lose any of his own wealth. How would modern bank regulation frustrate his scheme?

Bank regulations would require him to still have money in reserves. 7% of his assets

Explain why a system of commodity- backed money uses resources more efficiently than a system of commodity money.

Commodity-backed money has some resources on hand that money can be exchanged for but it is still mostly used for trade while commodity money does not

Suppose you hold a gift certificate, good for certain products at participating stores. Is this gift certificate money? Why or why not?

No because it is not a good medium of exchange in all situations.

Suppose you are a depositor at First Street Bank. You hear a rumor that the bank has suffered serious losses on its loans. Every depositor knows that the rumor isn't true, but each thinks that most other depositors believe the rumor. Why, in the absence of deposit insurance, could this lead to a bank run? How does deposit insurance change the situation?

People would still fear they would lose their money. Deposit insurance keeps people from rushing to take out their money because they know it is backed by the government.

What relationship would you expect to find between the level of development of a country's financial system and its level of economic development? Explain in terms of the country's levels of savings and investment spending.

Positive. If a country has a more advanced financial system it is easier for businesses to get loans etc. and for the economy to grow.

a. Calculate the net present value of each of the three hypothetical projects described below. Assume the interest rate is 5%. Project A: You receive an immediate payoff of $1,000. Project B: You pay $100 today in order to receive $1,200 a year from now. Project C: You receive $1,200 today but must pay $200 one year from now. b. Which of the three projects would you choose to undertake based on your net present value calculations? Explain.

Project A: $1000 because it is immediate Project B: -100(paying)+ (1200/(1+.05) to the first power because it is one year from now. you get 1042.86 Project C: 1200 - (200/1.05 to the first because it is one year) you get 1009.53. I would undertake project B as it has the highest present value.

Draw a correctly labeled graph showing equilibrium in the loanable funds market.

Th vertical axis is labeled Interest rate and the horizontal axis is labeled quantity of loanable funds. slope and demand intersect at point e

Draw three correctly labeled graphs of the money market. Show the effect of each of the following three changes on a separate graph. a. The aggregate price level increases. b. Real GDP falls. c. There is a dramatic increase in online banking.

The vertical axis is interest rate and the horizontal is quantity of money demanded. a. the demand curve will shift to the right b. demand curve shifts left c. demand curve shifts left

a. What is the amount you will receive in three years if you loan $1,000 at 5% interest? b. What is the present value of $1,000 received in three years if the interest rate is 5%?

a. I would recieve 1000*(1.05)cubed because it is over 3 years. this equals 1157.625 b. the present value would be 1000 divided by (1.05) cubed because you are going backwards. this would equal 863.84

Which of the following is the most liquid monetary aggregate? a. M1 b. M2 c. M3 d. near-moneys e. dollar bills

a. M1 because currency and checkable deposits are directly usable as a medium of exchange and M1 is the most liquid

a. What does it mean for an asset to be "liquid"? b. Which of the assets listed below is the most liquid? Explain. A Federal Reserve note (dollar bill) A savings account deposit A house c. Which of the assets listed above is the least liquid? Explain. d. In which monetary aggregate(s) calculated by the Federal Reserve are checkable deposits included?

a. an asset is liquid when it is easily converted into cash. b. A federal reserve note, it is already cash c. a house, it takes time and resources to sell it d. M1 and M2

Use a diagram of the loanable funds market to illustrate the effect of the following events on the equilibrium interest rate and quantity of loanable funds. a. An economy is opened to international movements of capital, and a capital inflow occurs. b. Retired people generally save less than working people at any interest rate. The proportion of retired people in the population goes up.

a. capital inflow occurs and the supply curve shifts to the right increasing the quantity of loanable funds and decreasing the interest rate. b. the supply curve shifts left because they are saving less and feel "richer"

Explain how each of the following would affect the quantity of money demanded, and indicate whether each change would 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 taxes, a vast underground economy develops in which workers are paid their wages in cash rather than with checks.

a. decrease in quantity of money demanded, movement on the curve b. decrease in quantity of money demanded, left shift of the curve c. decrease in quantity of money demanded leftward shift of the curve d. increased quantity of money demanded, right shift of the curve

Both lenders and borrowers base their decisions on a. expected real interest rates. b. expected nominal interest rates. c. real interest rates. d. nominal interest rates. e. Nominal interest rates minus real interest rates.

a. expected real interest rates (Fisher effect)

The required reserve ratio is 5%. a. If a bank has deposits of $100,000 and holds $10,000 as reserves, how much are its excess reserves? Explain. b. If a bank holds no excess reserves and it receives a new deposit of $1,000, how much of that $1,000 can the bank lend out and how much is the bank required to add to its reserves? Explain. c. By how much can an increase in excess reserves of $2,000 change the money supply in a checkable-deposits-only system? Explain.

a. its required reserves are .05*100,000 which equals 5000. 10000-5000 equals 5000 in excess reserves. b. It can lend out 950 but must keep 50 in reserves as (1000)*.05 is 50. c. The money multiplier is 1/.05 which equals 20. so 2000*20 equals 40000. the money supply can change by 40000

Suppose that expected inflation rises from 3% to 6%. a. How will the real interest rate be affected by this change? b. How will the nominal interest rate be affected by this change? c. What will happen to the equilibrium quantity of loanable funds?

a. real interest rate is unaffected b. nominal interest rate will rise c. the expected quantity will stay the same

The fraction of bank deposits actually held as reserves is the a. reserve ratio. b. required reserve ratio. c. excess reserve ratio. d. reserve requirement. e. monetary base.

a. reserve ratio

. Which of the following contributed to the financial crisis of 2008? a. subprime lending b. securitization c. deleveraging d. low interest rates leading to a housing boom e. all of the above

a. subprime lending is the lending to home buyers who don't meet the usual requirements for being able to attend the payments

Which of the following is a part of both the Federal Reserve System and the federal government? a. the Federal Reserve Board of Governors b. the 12 regional Federal Reserve Banks c. the Reconstruction Finance Corporation \d. commercial banks e. the Treasury Department

a. the federal reserve board of governors

How will each of the following affect the money supply through the money multiplier process? Explain. a. People hold more cash. b. Banks hold more excess reserves. c. The Fed increases the required reserve ratio.

a. the money supply will decrease because money held as cash does not support multiple dollars in the money supply. b. it will decrease as less money is being loaned out. c. it will decrease as banks hold more money and lend out less

How will each of the following affect the opportunity cost or benefit of holding cash? Explain. a. Merchants charge a 1% fee on debit/credit card transactions for purchases of less than $50. b. To attract more deposits, banks raise the interest paid on six-month CDs. c. Real estate prices fall significantly. d. The cost of food rises significantly

a. the opportunity cost of holding money lowers. b. the opportunity cost of holding money increases c. opportunity cost lowers because the things to buy are now cheaper d. the opportunity cost is higher because more money is needed to buy things?

a. What are the three major tools of the Federal Reserve System? b. What would the Fed do with each tool to increase the money supply? Explain for each.

a. the three major tools are the 1.discount rate 2. the reserve requirement and 3. open-market operations. b. to increase the money supply the fed would 1. decrease the discount rate to make it closer to the federal funds rate. this would make it easier for borrowers and increase the supply. 2. they would lower the reserve requirement so more money is available to be lent out. 3. the fed would make an open-market purchase. in doing so they would increase banks excess reserves. this would leave more money for banks to lend out and thus would increase the money supply via the money multiplier

The federal government is said to be "dissaving" when a. there is a budget deficit. b. there is a budget surplus. c. there is no budget surplus or deficit. d. savings does not equal investment spending. e. national savings equals private savings.

a. there is a budget deficit. the government is spending more than it is taking in.

Does each of the following affect either the supply or the demand for loanable funds, and if so, does the affected curve increase (shift to the right) or decrease (shift to the left)? a. There is an increase in capital inflows into the economy. b. Businesses are pessimistic about future business conditions. c. The government increases borrowing. d. The private savings rate decreases.

a. this causes the supply to shift right b. this causes the demand to shift left c. the demand shifts right d. the supply shifts right

Which of the following is a function of the Federal Reserve System? I. examine commercial banks II. print Federal Reserve notes III. conduct monetary policy a. I only b. II only c. III only d. I and III only e. I, II, and III

d. 1 and lll only. federal reserve notes are printed by the U.S. Treasury

If the interest rate is 5%, the amount received one year from now as a result of lending $100 today is a. $90. b. $95. c. $100. d. $105. e. $110.

d. 105$

Which of the following will decrease the demand for money? a. an increase in the interest rate b. inflation c. an increase in real GDP d. an increase in the availability of ATMs e. the adoption of Regulation Q

d. an increase in the availability of ATMs

The monetary base equals a. currency in circulation. b. reserves held by banks. c. currency in circulation − reserves held by banks. d. currency in circulation + reserves held by banks. e. currency in circulation/reserves held by banks.

d. currency in circulation + reserves held by the bank

Bank reserves include which of the following? I. currency in bank vaults II. bank deposits held in accounts at the Federal Reserve III. customer deposits in bank checking accounts a. I only b. II only c. III only d. I and II only e. I, II, and III

d. l and ll only

Decreasing which of the following is a task of the financial system? I. transaction costs II. risk III. liquidity a. I only b. II only c. III only d. I and II only e. I, II, and III

d. l and ll only

A change in which of the following will shift the money demand curve? I. the aggregate price level II. real GDP III. the interest rate a. I only b. II only c. III only d. I and II only e. I, II, and III

d. l and ll only a change in interest rate would be movement along the curve

When you use money to purchase your lunch, money is serving which role(s)? I. medium of exchange II. store of value III. unit of account a. I only b. II only c. III only d. I and III only e. I, II, and III

d. l and lll only. 3 is a unit of account cost because it is a measure used to set a price and make economic calculations

A nonprofit institution collects the savings of its members and invests those funds in a wide variety of assets in order to provide its members with income after retirement. This describes a a. mutual fund. b. bank c. savings and loan. d. pension fund. e. life insurance company

d. pension fund

Which of the following is true regarding short-term and long-term interest rates? a. Short-term interest rates are always above long-term interest rates. b. Short-term interest rates are always below long-term interest rates. c. Short-term interest rates are always equal to long-term interest rates. d. Short-term interest rates are more important for determining the demand for money. e. Long-term interest rates are more important for determining the demand for money.

d. short-term interest rates are more important for determining the demand for money

Who oversees the Federal Reserve System? a. the presidents of the Regional Federal Reserve Banks b. the president of the United States c. the Federal Open Market Committee d. the Board of Governors of the Federal Reserve System e. the Reconstruction Finance Corporation

d. the board of governors of the federal reserve system

When the Fed makes a loan to a commercial bank, it charges a. no interest. b. the prime rate. c. the federal funds rate. d. the discount rate. e. the market interest rate.

d. the discount rate

In the United States, the dollar is a. backed by silver. b. backed by gold and silver. c. commodity-backed money. d. commodity money. e. fiat money

e. fiat money

Which of the following is NOT a type of financial asset? a. bonds b. stocks c. bank deposits d. loans e. houses

e. houses. a financial asset is a paper claim that entitles the buyer to future income from the seller. a house is a physic asset

Suppose, for simplicity, that a bank uses a single interest rate for loans and deposits, there is no inflation, and all unspent money is deposited in the bank. The interest rate measures which of the following? I. the cost of using a dollar today rather than a year from now II. the benefit of delaying the use of a dollar from today until a year from now III. the price of borrowing money calculated as a percentage of the amount borrowed a. I only b. II only c. III only d. I and II only e. I, II, and III

e. l ll and lll

Bank regulation includes which of the following? I. deposit insurance II. capital requirements III. reserve requirements a. I only b. II only c. III only d. I and II e. I, II, and III

e. l, ll, and lll

Which of the following financial services does the Federal Reserve provide for commercial banks? I. clearing checks- moving money basically II. holding reserves III. making loans a. I only b. II only c. III only d. I and II e. I, II, and III

e. l, ll, and lll ?

The quantity of money demanded rises (that is, there is a movement along the money demand curve) when a. the aggregate price level increases. b. the aggregate price level falls. c. real GDP increases. d. new technology makes banking easier. e. short-term interest rates fall.

e. short-term interest rates fall. movement is only caused by changes in interest rates