TOPHAT Chapter 11: Money

Which of the following is an example of bartering?

(b) A cabinet maker gives the plumber a desk since the plumber fixed the cabinet maker's plugged bathtub.

Which of the following is a store of value?

A, C, and D all have a store of value. While C and D are not money, they are purchased with money and if the owner wishes, he or she can sell the gold or the painting. These goods are easily converted to money. B is not correct. Credit cards do not hold value and are considered short term loans.

What determines how much the money supply can expand?

All three were discussed in the chapter. More deposits mean more loans can be made. Larger excess reserves mean a lower amount of loans and a smaller money supply. The required reserve ratio determines how much $1 deposited into a bank will change the supply of money if loans are made.

You have $10,000 in your pocket today. If the currency is deposited into a bank account paying 4 percent interest, what is the future value of that deposit in one year?

Allow the deposit to grow at 4 percent. So for each dollar deposited, it grows by $0.04 and $10,0000.04 is $400, which means $10,000 grows into $10,400. Using the formula: future value = $10,000(1+0.04) = $10,400. Notice how doubling your deposit simply doubles the interest earned. [24.9]

You have $5,000 in your pocket today. If the currency is deposited into a bank account paying 4 percent interest, what is the future value of that deposit in one year?

Allow the deposit to grow at 4 percent. So for each dollar deposited, it grows by $0.04 so $50000.04 is $200 which means $5000 grows into $5200. Using the formula: future value = $5,000(1+0.04) = $5,200 [24.9]

You have $10,000 in your pocket today. If you deposit $5,000 into bank A and $5,000 into bank B with both accounts earning 4 percent interest, what is the future value of this deposit in one year?

Allow the deposit to grow at 4 percent. So for each dollar deposited, it grows by $0.04 so for bank A and bank B you would have for each bank $5,000*0.04 or $200 in interest from each bank account. This means you earn $400 in total from both banks and in one year you would have $10,400. Notice how this is the same interest you would earn and have in one year if you just put the currency into one bank account at bank A or B. [24.9]

An increase in interest rates causes the:

An increase in interest rates increases the opportunity cost of holding currency. As the cost of holding currency increases and the benefits do not change, the quantity demanded of money will fall. [24.8]

The simple money multiplier will ______________ as the required reserve ratio ______________

As the required reserve ratio gets smaller or decreases, banks have excess reserves and can create more loans. This means the simple money multiplier must increase. This also causes the quantity of money in the economy to increase. [24.7]

Assume that bank reserves are equal to $2,000, and the required reserve ratio is changed from 10 percent to 20 percent. Banks make as many loans as they can. What is the upper limit of the money supply when the required reserve ratio is increased? Also, assume no borrower withdraws currency and leaves the loan balance in the bank after a loan is created.

At 10 percent, the upper limit is $20,000 and at 20 percent, the upper limit is $10,000. The simple money multiplier is equal to 5; this is from 1/0.20. This means for every one dollar deposited, the banks can loan out $5. Thus, the upper limit is equal to $2,000 times 5. Another way to calculate the result is to think about the maximum amount of deposits banks can support with $2,000 in reserves. What are the total loans when 20% is held as reserves? $2,000 = 0.20 (total deposits) or $200 / 0.20 = $10,000. Finally, one last thing to notice is that when the required reserve ratio is doubled, the upper limit is reduced by half.

Bitcoins are used to purchase goods and services from certain vendors. This is evidence that Bitcoin fulfills which of the following functions of money?

Bitcoins are a medium of exchange (for those stores that accept it). As discussed above, Bitcoin is not a very good store of value or unit of account because the value is volatile.

Store owners in the U.S. accept dollars for the purchase of goods and services. Every day, you have woken up and believed that the exchange of dollars for goods and services could occur. Why?

Both you and the seller of goods and services use money as a medium of exchange. You and the seller are willing to use money for the transaction so that you do not have to barter. You and the seller believe dollars serve as money.

What is the opportunity cost of holding currency?

By holding currency, you do not earn interest. Therefore, by holding currency, the cost is what you give up, which would be the interest rate. [24.8]

What are the desirable characteristics of the good used as money?

C is not correct. The definition provided earlier does not mention money holding its value through time. The example of money holding value overnight does not mean that money will hold the exact same value through time. For example, a dollar in three years from now may not be able to purchase the exact same goods and services that it can purchase today.

Credit cards are part of

Credit cards are not money. Credit cards are a means of transferring money. The credit card firm pays for your purchase and then you pay the credit card company the money it used to pay for your purchase.

Currently, bank reserves are equal to $2,000, the required reserve ratio is 10 percent, banks make as many loans as they can, and no borrower withdraws currency and leaves the loan balance in the bank after a loan is created. But now banks decide to increase their reserves and start to hold 15 percent of their reserves. Assume this change is permanent. How much will the money supply change?

Currently, bank reserves are equal to $2,000, the required reserve ratio is 10 percent, banks make as many loans as they can, and no borrower withdraws currency and leaves the loan balance in the bank after a loan is created. But now banks decide to increase their reserves and start to hold 15 percent of their reserves. Assume this change is permanent. How much will the money supply change?

Today you have $10. If the interest rate is 3.25 percent, what is the future value of that $10 one year from now?

Each dollar earns $0.0325. Since there is $10, then the interest earned is 0.325. If we add the interest earned for each dollar, we have $0.325 earned so in one year you would have $10.33. Or we can use the formula: future value = $10*(1+0.0325) = $10.33 [24.11]

The interest rate is 6 percent; in one year from today, what is the future value of $500?

For each $1, it grows at $0.06, so if we sum this over 500 one dollar bills we have $530. Or we can use the formula: future value = $500*(1+0.06) = $530

What would happen to the money market if there was an increase in economic growth?

If economic growth increases, real GDP grows at a faster rate. Real GDP has a positive effect on the demand for money, so demand for money will increase. The demand curve will shift outwards. The shortage of money will cause interest rates to rise. The money market will reach a new equilibrium at a higher interest rate.

If banks were required to keep 100 percent in reserves, and if all the currency in the economy was deposited into a bank, then:

If we have 100 percent reserve banking, then by definition this means that 100 percent of the deposit must be kept as reserves so nothing is lent out. Instead of people holding their currency, the bank is holding it for them. No additional money can be created with 100 percent reserve banking.

A friend has won a lottery and comes to you and asks which choice he should take. Either $185 million paid one year from now or $165 million paid now? What would you tell him to do?

If you told him to take the currency today or told him to take the currency a year from now, you are likely making this choice based on intuition or personal preferences. The correct answer would be that this question cannon be answered. There is not enough information to make a choice. Specifically, what is missing is the interest rate that could be earned if the $165 was deposited and earned interest for a year. [24.11]

You have a choice of either $1,000 today or $1,500 in 5 years. If the interest rate is 8 percent, which choice gives you the highest amount of money?

If you took $1,000 today and deposited it into the bank at 8 percent interest, then in 5 years you would have $1,469.33. So the question now becomes, in five years would you rather have $1,496.33 or $1,500? You would take $1,500 in 5 years.

Liquidity means

Liquidity means how quickly something can be converted to currency. An asset is more liquid if there are fewer steps involved to convert the asset to the medium of exchange without incurring large penalties, fines, or fees.

Currently, bank reserves are equal to $2,000, the required reserve ratio is 10 percent, banks make as many loans as they can, and no borrower withdraws currency and leaves the loan balance in the bank after a loan is created. There is $500 in currency that is found and deposited into the bank. Assume that the currency was not previously in the banking system and is permanent. How much has the money supply increased?

Originally, the upper limit was $20,000 and with the new reserves of $2,500 the maximum amount of loans that can be created is $25,000. This means the money supply increases by $5,000. Notice how the same amount whether it is a decrease or an increase in the reserves causes the reserves to change by the same amount. Be aware of this during exams and be careful!

Currently, bank reserves are equal to $2,000, the required reserve ratio is 10 percent, banks make as many loans as they can, and no borrower withdraws currency and leaves the loan balance in the bank after a loan is created. A news report has made people want to carry currency, and this causes the reserves to fall to $1,500. Assume the change is permanent. How much has the money supply decreased?

Originally, the upper limit was $20,000, and with the new reserves of $1,500, the maximum amount of loans that can be created is $15,000. This means the money supply decreases by $5,000.

Suppose that banks keep no excess reserves and individuals and firms hold on to no currency. If someone finds $7.5 million in currency and deposits all of it into a checking account, what is the upper limit or maximum amount of the money supply when the required reserve ratio is 10 percent?

The $7.5 million will expand to a total of $75 million. The $7.5 million is deposited in a bank. The bank will lend out 90 percent. That 90 percent will be deposited in another bank, which will in turn lend out 90 percent of the new deposit. This process will continue until the money supply has expanded to $75 million. The money supply is supported by $7.5 million in required reserves as currency in the banks' vaults.

If individuals hold less currency because it is easy to get currency from automatic teller machines, and everything else is the same, will the money supply be larger or smaller?

The money supply should rise since people are holding onto less currency. If the currency was in the bank, the banks could lend it out. [24.7, 24.8]

Suppose that you have a bond that originally cost you to $1,000 to purchase. It pays you $50 in interest each year. That interest payment does not change, and the original purchase price will be returned to you far in the distant future. What would happen to the current market price of your bond (yes, there is a market, and you can resell the bond to someone else) if interest rates for all similar bonds in the economy rise to 6 percent?

The price of the bond will fall. Your bond only pays 5 percent, which is from $50 divided by $1,000. No one will be willing to pay as much as $1,000 for your bond when they can buy a $1,000 bond that pays 6 percent. Thus, the price of your bond will fall.

How would the money market change if there was an increase in bank reserves?

The supply of money is affected by bank reserves and the required reserve ratio. If bank reserves increase, banks excess reserves will become larger and banks will have the ability to make loans and create money. This will expand the money supply. The supply curve will shift outwards, creating a surplus at current interest rates. The money market will reach a new equilibrium at a lower interest rate and a higher quantity of money.

If bank reserves are equal to $2,000, the required reserve ratio is 10 percent, and banks make as many loans as they can, what will be the upper limit of the money supply assuming no borrower withdraws currency and leaves the loan balance in the bank after a loan is created?

The upper limit from $2,000 in reserves would be $20,000. The simple money multiplier is equal to 10; this is from 1/0.10. This means for every one dollar deposited, banks can create $10 in loans. Thus, the upper limit is equal to $2,000 times 10. Another way to calculate the result is to think about the maximum amount of loans that banks can support with $2,000 in reserves. That is, if $2,000 is the required reserves and this is 10 percent of the loans created, then what is the sum of all the loans created? This would be $2,000 = 0.10 (total deposits). $2,000 / 0.10 = $20,000.

The broader definition of the money supply M(2) includes

This is by definition of M(2). Small time Certificates of Deposit are part of M(2) but not part of M(1). Checkable deposits are part of M(1) which is part of M(2). [24.6]

A friend has won a lottery and comes to you and asks which choice he should take. Either $185 million spread out over 5 annual payments or $165 million paid now. If the average interest rate is six percent, what would you tell him to do?

To calculate the present value of the $ 185million spread out over 5 years, I would first divide the $185 million by 5 years, getting $37 million per year. Then I would use the following formula: Present Value = $37m / (1.06) + $37m /(1.06)^22 + $37m /(1.06)^33 + $37m /(1.06)^44 + $37m /(1.06)^55 . Summing this sequence gives us a present value of $155.857 million. This means you should take $165 million now. If $155.857 million was deposited today, it will grow to $185 in five years. So if $165 million is deposited today, you would have more than $185 in five years.

If prisoners did not have dollars to use to purchase goods and services in prison but they had access to Top Ramen noodles that is then used as money by the prisoners, then Top Ramen becomes:

Top Ramen can be used to purchase other goods. Additionally, Top Ramen can be a unit of account. For example, a serving of Top Ramen could be worth two pencils or one apple. The prisoners set the prices in the economy and determine what Top Ramen can purchase. Finally, Top Ramen is also a store of value meaning that the prisoners could hold onto the Top Ramen and not use it immediately- essentially save it until they wanted to make a purchase. This would mean that Top Ramer is a store of value. Thus, Top Ramen satisfies the characteristics of money. [24.3, 24.4]

Which of the following is not included in bartering?

Typically, money is omitted from bartering. Most people are bartering goods and/or services. If you have money and are willing to use it, then bartering likely won't occur.

The U.S. $20 dollar bill is a commodity:

U.S. dollars have one use- money but has no other value and is not used for any other purpose than money. Therefore, U.S. dollars have no intrinsic value.

Today you have $700. If the interest is 9 percent, what is the future value of $700 in one year from now?

Use the future value formula or think about it this way: each one dollar earns $0.09 per year. If we add this 700 times (since each one dollar earns interest), then after one year we would have $700*0.09=$63 in interest. Add the original $700 that is in the bank and we now have $763.

Three years ago, you put $1,500 into an account paying 3 percent interest. How much is the account worth today?

Use the future value formula since the initial deposit earned interest for three years. You would need to account for the interest on interest meaning the interest you earn will also earn interest through time. This is easiest done with the future value formula. Using the formula: future value = $1,500*(1+0.03) = $1,639.09 [24.9]

Which of the following will likely cause an increase in the supply of money?

When a bank has excess reserves, they can either lend the excess reserves to a borrower and earn interest or keep it as excess reserves but earn no interest. Therefore, they are likely to make more loans and thus more money will be created.

Which of the following will result in a decrease in the supply of money in the economy?

When a borrower is paying off a loan, the bank collects the borrower's currency. If no new loans are created from this currency, then the money supply shrinks. For example, if the borrower paid $1 of the loan to the bank, then that $1 is not being lent out to another customer. Recall the simple money multiplier causes the money supply to grow. So when $1 is not loaned, then the growth that was created by the simple money multiplier does not occur. The money supply will decrease if the bank holds the $1 and does not lend it out then that $1 shrinks the economy by the amount of the simple money multiplier. [24.7]

An increase in spending in the economy will cause which of the following changes in interest rates?

When people are spending more money, the economy is expanding or doing well, people demand more money or currency.

You receive dollars for payment when you mow your neighbor's lawn. Which function of money does this best demonstrate?

You are selling your time. Your neighbor is purchasing your labor. Money helps this transaction occur.

You have $4,000 in your pocket today. If you deposit this into a bank account paying 4 percent interest, what is the future value of that money in one year?

a$4,610

If $800 is deposited into a bank account earning 8% interest, how much will this become if the banks make the most loans they can?

a-$10,000

M(1) includes:

a-Currency. b-Demand deposits. c-Travelers checks.

The people of MicroIsland use sea shells as a way of exchanging goods and services. The shells are:

c-Not money because the government didn't print it.

What is the opportunity cost of $1.00 when the interest rate is 60 percent?

d-The opportunity cost is $0.60.