Chapter 27 (Money and Banks)
What are the three functions of money? Explain them.
1. Money serves as a medium of exchange, which means it acts as an intermediary between the buyer and the seller. 2. Money serves as a store of value which limits the risk because you know that you can store it and don't have to spend it right away. 3. Money serves as a unit account, which means it determines how we measure value in the market.
How do banks go bankrupt?
Banks go bankrupt by having a negative net worth, meaning its assets will be worth less than it's liabilities. If the bank doesn't take into account an excess number of loan defaults it can cause them to lose a lot of money especially during a recession.
Explain a bank's balance sheet.
A banks balance sheet is an accounting tool that lists assets and liabilities. In the bank's case, it consists of Loans, U.S. government securities, and Reserves as the assets they hold. While the Deposits and Net worth are the Liabilities they hold.
How do banks create money?
It is possible because there are multiple banks in the financial system, which they are required to hold only a fraction of their deposits, and loans end up deposited in other banks which increases deposits and in essence the money supply.
What's the problem with that system?
It's highly inefficient for trying to coordinate the trades in the modern world advanced economy since a double coincidence of wants is difficult to arrange especially between two countries.
What are the three bank assets?
Loans, The U.S. Government Securities Reserves.
What is money?
Money serves as a medium of exchange, which means it acts as an intermediary between the buyer and the seller.
Before money, how did people pay for what they wanted?
People paid for the things they wanted by engaging in the barter system which is literally trading one good in for another.
How do banks receive revenue?
Since the banks act as an intermediary for the financial interaction, they take fees and interest payments on the money lent out which comes to them as revenue.
What is the M1 money supply?
The M1 money supply is one of the two definitions of money and it includes those monies that are very liquid such as cash, checkable deposits, and traveler's checks.
What is the M2 money supply?
The M2 money supply is the second definition of money which is less liquid in nature and includes M1 money supply plus savings and time deposits, certificates of deposits and money market funds.
What are the expenses banks incur?
The expenses banks incur are the transaction costs that are associated with finding a lender or a borrower. They also incur costs from their liabilities such as deposits and net worth.
What is the reserve ratio?
The reserve ratio is the portion of reservable liabilities that depository institutions must hold onto, rather than lend out or invest.
Where do banks get funds to loan out?
They get the funds from individuals who would like to store their money in a bank rather than seek out a lender and essentially being the borrower and the lender together for the transaction.
How is the money multiplier calculated?
You take the money multiplier formula and then multiply it by the change in excess reserves to determine the total amount of M1 money supply creates by the banking system.
