Download Time Value, Velocity, and Quantity of Money, Liquidity, the Reserve

This is
Macroeconomics
the
In this chapter, we will examine the role of money and banks in
the economy. We will look at how central banks, such as the
FED (the FederalReservein the U.S.), regulate the money
supply in our country. The Fed also regulates banks and makes
sure people have faith in our financial system.
Page1
Whatis YourMone}'Worth?-PresentValue
If you met someone in college and they told you that they had
$100,000 and that they had invested money for only one year
at 5% to earn it, how much did they start with/originally
invest? Present value=
$ present value
(1 + the interest in decimals) to the nth power (the length in years)
$l00,0001 = $95 238.10
(1.05)
'
*If you have $100 after investing your money for 3 years at
8% interest, how much did you start with?
*At 12% interest for 4 years?
Page2
Whatis YourMone}'Worth?-FutureValue
Would you rather have $100 today or $200 in two years? You
can determine how much your money will be worth in the
future. if you know the interest rate and the number of years.
Future value==
$ present value x (1 + the interest in decimals)
to the nth power (the length in years)
1
$100 X (1.05)==$105
1
A present value of $100 at 5% interest for one year would
equal $105: $100 (1.05).
2
*At the end of a second year
110.25 $100 x (1.05)
3
*At the end of a third year
115.76· $100 x (1.05)
4
*At the end of a fourth year
Page3
121.55 $100 x (1.05)
Introduction-Questions
49. Which of the following be t de cribe the pre ent
alue of one dollar recei ed one year from today?
A It i worth more than a dollar recei ed today.
(B It i worth le than a dollar recei ed today .
{C It ha the ame value a a dollar received
today .
(D It decrease a intere t rate decrea e.
E It i not affected by change in intere t rate .
Page4
Introduction-Questions
49. Which of the following be t de cribe the pre ent
alue of one dollar recei ed one year from today?
A It i worth more than a dollar recei ed today.
(e ) It i worth le than a dollar recei ed today .
{C It ha the ame value a a dollar received
today .
(D It decrease a intere t rate decrea e.
E It i not affected by change in intere t rate .
Page5
Whatis YourMone>'Worth?-Questions
_5. If the nnual int r t r t i 5 perc nt then the
pr nt alu f$1.00r c i d n y rfrotn
no i cl
tt
$1.50
1.05
$1.00
D $0.95
E $0.05
Page6
Whatis YourMone>'Worth?-Questions
_5. If the nnual int r t r t i 5 perc nt then the
pr nt alu f$1.00r c i d n y rfrotn
no i cl
tt
$1.50
1.05
$1.00
• $0.95
E $0.05
Page7
Measuresof the MoneySupply
Economists define the money supply , M, as currency plus
checking, savings, and time deposits. Currency and checking
are considered assets and by themselves are reff ered to as Ml
and are considered a demand deposit (currency that you
deposit into a bank account from which you can withdraw "on
demand" - at any time without any advance notice to the bank;
liquidity).
Page8
Measuresof the MoneySupply-Questions
7. Of the following~ the mo t liquicl a et i
A mutual fund
B currency
C time depo it
D demand depo it
E a ing depo i
I 0. An increa e in government pending will affect
the demand for money and nominal intere t rate
in which of the following way ?
(A
B
C
D
E
Page9
Demand for Money
Nominal
[ntere t Rate
Increa e
Increa e
Increa e
Decrease
Decrea e
[ncrea e
Decrea e
[ndeterminate
[ncrea e
Decrea e
Measuresof the MoneySupply-Questions
7. Of the following~ the mo t liquicl a et i
mutual fund
currency
time depo it
demand depo it
a ing depo i
I 0. An increa e in government pending will affect
the demand for money and nominal intere t rate
in which of the following way ?
•
B
C
D
E
Page10
Demand for Money
Nominal
[ntere t Rate
Increa e
Increa e
Increa e
Decrease
Decrea e
[ncrea e
Decrea e
[ndeterminate
[ncrea e
Decrea e
Measuresof the MoneySuggly-Questions
,_j
UJ
>
UJ
.....J
u.:i
u
.........
Or:::
~
AD1
0
REAL GROSS
DOMESTIC
PRODUCT
17. The graph above
how two aggregate demand
upply
curve
AD 1 and AD 2 and an aggregate
curve, AS. The shift in the aggregate demand
curve from AD 1 to AD 2 could be cau ed by
A
B
C
D
E)
Page11
a decrease in taxes
a decrease in the money
upply
an increa e in government
pending
an increa e in consumption
spending
an increa e in the price level
Measuresof the MoneySuggly-Questions
,_j
UJ
>
UJ
.....J
u.:i
u
.........
Or:::
~
AD1
0
REAL GROSS
DOMESTIC
PRODUCT
17. The graph above
how two aggregate demand
upply
curve
AD 1 and AD 2 and an aggregate
curve, AS. The shift in the aggregate demand
curve from AD 1 to AD 2 could be cau ed by
A
a decrease in taxes
•
a decrease in the money
upply
(C an increa e in government
pending
D an increa e in consumption
spending
E) an increa e in the price level
Page12
Macroeconomics
Do-Now
Please do this:
1. Assume the United States economy is currently in longrun equilibrium.
a. draw a correctly labeled graph of long-run aggregate
supply, short-run aggregate supply, and aggregate
demand at equilibrium
b. draw a long-run and short-run Phillips curve at
equilibrium
c. draw a single graph with the short-run Phillips curve
2. On all three graphs, show the impact of the FED
monetary policy of selling b,onds to banks.
Page13
Macroeconomics
Do-Now
Please do this:
1.
Price
Level
Phillips Curve
• Long-run
. Aggregate
Supply
Inflation
Short-<un
Aggregate
Supply
LRPC
P ·
Aggregate
Demand
SRPC
Uv
~GDP
Natura l Rate
of Output
Unemplo yment
Short Run Phillips Curve
1. full employment
level
2. full output level
3. natural rate of
unemployment
Inflation
SRPC
Unemplo yment
Page14
Macroeconomics
Do-Now
Phillips Curve
Please do this:
3.
Price
Level
--
• Long-run
. Aggregate
Supply
Inflation
LRPC
Short-<un
Aggregate
Supply
I
L"pca.
P ·
Aggregate
Demand
I
SRPC
Uy
Natura l Rate
of Output
Unemplo yment
Short Run Phillips Curve
Inflation
....................
.
...
...
SRPC 1
SRPC
Unemplo yment
Page15
II
TheVelocit)'and QuantityTheoryof Money
The velocity of money is the average frequency with which a
unit of money is spent in an economy. For example, assume a
very small economy that has a money supply of $100 and has
only two people. Bob sells pencils and Jane sells paper. Bob
starts with the $100 and buys $100 worth of paper from Jane.
Jane turns around and buys $100 worth of pencils from Bob.
Bob and Jane's economy now has a GDP/nominal GDP/current
GDP of $200 even though the money supply is only $100. If
Bob and Jane do the same two transactions every month, their
nominal GDP will be $2,400 per year, though the money
supply is only $100. The equation for velocity is:
velocity of money = GDP / starting money supply
ali
Page16
::.
.Ql,40'0/ _»I () 0
TheVelocit)'and QuantityTheoryof Money
Velocity of money is an incredibly important component /part
of an economy's GDP calculation. GDP cannot be controlled
through the money supply alone. If the money supply is
increased, but velocity decreases, GDP may stay the same or
even decline . Price levels will also rise because of the
abundance of money. Along the same idea, the quantity
theory of money states that there is a direct relationship
between the quantity of money in an economy and the level of
prices of goods and services sold. The theory states that the
quantity of money is positively related to nominal ouput and
nominal GDP. An increase in the money supply causes prices
to rise (inflation). A decrease first causes disinflation (when
the rate of inflation slows down) which then leads to deflation
(a declining inflation rate).
Page17
TheVelocit)'and QuantityTheoryof Money-?s
44. Given a con tant velocity of money~ in the hort
run a 5 percent increa e in money upply will
tran late to a 5 percent increa e in
(A
(B
C
(D
(E
governmen t budoet deficit
real gro dome tic product
nominal gro dome tic product
real intere t rate
norninal intere t rate
7. According to the quantity theory of money ,
the quantity of money i related
(A
B
C
D
(E
Page18
negatively to the nominal intere t rate
negatively to the price level
po itively to the elocity of money
po itively to the unemployment rate
po itively to the nominal gro dome tic
product
TheVelocit)'and QuantityTheoryof Money-?s
44. Given a con tant velocity of money~ in the hort
run a 5 percent increa e in money upply will
tran late to a 5 percent increa e in
(A
(B
(.
(D
(E
governmen t budoet deficit
real gro dome tic product
nominal gro dome tic product
real intere t rate
norninal intere t rate
7. According to the quantity theory of money ,
the quantity of money i related
(A
B
C
D
(.
Page19
negatively to the nominal intere t rate
negatively to the price level
po itively to the elocity of money
po itively to the unemployment rate
po itively to the nominal gro dome tic
product
TheVelocit)'and QuantityTheoryof Money-?s
13. If the velocity of money i con tant and the
aggregate upply curve i vertical, a doubling of
the money upply would rno t likely re ult in a
doubling of
(A
(B
(C
D
E)
the unemployment rate
real output
the price level
nominal intere t rate
real intere t rate
3. If nominal gro dome tic product in a country i
$1,600 and the money upply i $400, what i the
elocity of money?
A 400
(B
10
C
4
D
2
(E
Page20
0.5
TheVelocit)'and QuantityTheoryof Money-?s
13. If the velocity of money i con tant and the
aggregate upply curve i vertical, a doubling of
the money upply would rno t likely re ult in a
doubling of
(A the unemployment rate
(B real output
the price level
nominal intere t rate
real intere t rate
3. If nominal gro dome tic product in a country i
$1,600 and the money upply i $400, what i the
elocity of money?
A 400
(B
10
4
(D
2
(E
Page21
0.5
velocity of money
L\ ~
== GDP
/ starting money supply
\>\~OC)(\~O'D
TheVelocit)'and QuantityTheoryof Money-?s
16. If lhe eloc ity of mon y is stable, he quantity
theory o a y p di ts that a · crease ·n
the·n10 ey uppl · i"l l d o a prop )rti al
(A) i 1crea e in t~e no ·nal output
(B) ;~creas in th pric [ v 1
(C)
~ ase in
e no · a in e ._t -a.it;
(D) decrease i "'e re 1 intere t rat
(B) decreasein t!1 unemplo)~men rat .
Page22
TheVelocit)'and QuantityTheoryof Money-?s
16. If lhe eloc ity of mon y is stable, he quantity
theory o a y p di ts that a · crease ·n
the·n10 ey uppl · i"l l d o a prop )rti al
Q ~
(B)
(C)
(D)
(B)
Page23
i 1crea e in t~e no ·nal output
;~creas in th pric [ v 1
~ ase in
e no · a in e ._t -a.it;
decrease i "'e re 1 intere t rat
decreasein t!1 unemplo)~men rat .
Why the FED Increasesand Decreasesthe MoneySupply
TheFEDincreases
the
money
supplyto
stimu
latetheeconomy..
TheFEDdecreases
the
money
supplytoslow
downtheeconomy
...
1. InterestRatesDecreases
2. Investment
Increases
3. AD, GDPandPLIncreases
Interest
Rate(i)
S&DofMoney
Interest
Rate(i)
Investment
Demand
1. InterestRatesincrease
2. Investment
decreases
3. AD,GDPandPLdecrease
Interest
Rate(i)
l
10%
10%
10%
5%
5%
5%
'
2% ------
PL
200 250 Quantiti)
'M
:
F>:D1
Interest
Rate(i)
Investment
Demand
Ml SM
10°/o,- -
5%
2%
2%
I
t:-1
I
,~,
,~,
I
I
I
175 200
Quantity
ofInvestment
PL
AD/AS
AD,
Page24
'
2% -----,--
S&DofMoney
AD/AS
Quantit)
'M
Quantity
ofInvestment
The Banks
A commercial bank, like Chase or Bank of America, accepts
deposits from individuals and makes loans. To understand how
a bank functions, it is necessary to look at its balance sheet,
which shows its assets, liabilities, and net worth. The table
below shows a balance sheet. The different items are divided
into assets and liabilities. An asset is something of value
owned by a person or firm. A liability is something of value
that a person or firm owes, such as a debt, to someone else.
Bank Balance Sheets
Assets
Loans
Reserves
Treasury Bonds
Total Assets
Liabilities
$8,000 Demand Deposits
$500 Owner's Equity
$1,500
$10,000 Total Liabilities
$5,000
$5,000
$10,000
It is ' 'balanced'' because the totals must equal
Page25
The Banks(cont.)
Loans are the money that the bank has and makes money off of by
loaning it to others. Loans are an asset because they are required
to be paid off to the bank by the borrowers. Reserves or the
reserve requirement or reserve ratio (usually about 10%) are the
percent of deposits that banks must hold in reserve at the FED and
cannot loan out.
Bank Balance Sheets
Assets
Loans
Reserves
Treasury Bonds
Total Assets
Page26
Liabilities
$8,000 Demand Deposits
\Oo/o$500 Owner' s Equity
$ 1,500
$5,000
$5,000
------------
$10,000 Total Liabilities
$10,000
The Banks(cont.)
Treasury bond s (T-bonds) are long-term bonds issued by the
U.S. Treasury. Demand deposits are currency that you deposit
into a bank account from which you can withdraw "on
demand" - at any time without any advance notice to the bank;
liquidity. Owner's equity is the investment at the bank made
by its owners. Because demand deposits and owner's equity
can be removed from the bank at any time, they are liabilities.
Finally , capital stock is the stock a company issues to obtain
increased funding.
Bank Balance Sheets
Assets
Loans
Reserves
Treasury Bonds
Total Assets
Page27
Liabilities
$8,000 Demand Deposits
$500 Owner's Equity
$1,500
$10,000 Total Liabilities
$5,000
$5,000
$10,000
The Banks(cont.)
As we know, giving loans is how banks make their money.
But, their loans also impact the money supply. Just like there
was a multiplier effect depending on a person's increase or
decrease in their MPC or MPS, there is also a multiplier effect
for currency. Imagine a group of 4 people who have items for
sale. Amy has $10, which she uses to buy Barbara's discount
movie tickets. Barbara uses the $10 and pays Chris for a CD,
who uses the $10 to buy LED Christmas lights from David.
So, in this instance, the same $10 was used in 3 transactions
for $30 worth of financial transactions.
Page28
The Banks(cont.)
See in detail how bank deposits are multiplied. Banks are the lenders and
businesses are the borrowers. There is a 10% reserve requirement or
reserve ratio
1. Bank of America lends 7-11 $1,000, who then pays a supplier
2. StrawCo the supplier then deposits the money in its own bank account
3. Chase (StrawCo's bank) can then lend out 90% of the deposit, or $900
4. Chilis borrows $900 and puts it into its bank, First Fidelity
5. First Fidelity can now lend out 90% of the $900 depositied, or $810
This leads to the fallowing series of payments with a 10% reserve
requirement or reserve ratio:
1. $1,000
2. $900 because the bank has to keep $100 in reserve
3. $810 because the bank has to keep $90 in reserve
4. $729 because the bank has to keep $81 in reserve
5. and so on
Page29
The Banks(cont.)
Because the banks keep some of each deposit as reserves, the
amount of additional financial transactions that a particular
deposit can generate is limited. The formula for the deposit
expansion multiplier, which is the money multiplier, is:
requiredreservesor initialamount= bank deposits
required reserve ratio
or ending amount
Hence, in the example we've used, if $1,000 is continually
redeposited with a 10% reserve ratio/requirement, then:
$1,000 I .I== $10,000
With a 10% reserve requirement /ratio, spending $1,000 will
ultimately lead to a $10,000 in financial transactions.
Page30
The Banks-Questions
42. As ume that Atlantic National Bank has demand
depo its of $100,000 and no exces re erve ,
and that the re erve requirement i 10 percent.
A cu tomer withdraw $5 000 from the bank .
To meet the reserve requirement, the bank rnu t
increase its re erve by
(A)
(B)
(C)
(D)
(E)
$500
$1 000
$2 ,000
$4 000
$4 500
45. As ume that Linda deposits in her checking
account the $1,000 cash he was keeping at
home for an emergency. If the required re erve
ratio is 0.20 what i the maximum change in the
money upply from her depo it?
(A) $1,000
(B) $1 250
(C) $2 000
(D) $4 000
(E) $5 ,000
Page31
The Banks-Questions
42. As ume that Atlantic National Bank has demand
depo its of $100,000 and no exces re erve ,
and that the re erve requirement i 10 percent. $100,000 - $5,000= $95,000
A cu tomer withdraw $5 000 from the bank . $95,000 / 10°/o = $9,500
To meet the reserve requirement, the bank rnu t $5 000 still in reserves =
increa se its re erve by
needed
$4:soo
(A) $500
(B) $1 000
(C) $2 ,000
(D) $4 000
$4 500
required reserves or initial amount
required reserve ratio
IC\5I0~ \),,..
r-_,,~.lr----
e)
bank deposits or ending amount
45. As ume that Linda deposits in her checking
account the .$_!,000 cash he was keeping at
home for an emergency. If the required re erve
ratio is 0.20 what i the maximum chan_g~in the
money upply from her deeo ilJ
(A) $1,000
(B) $1 250
(C) $2 ooo
4
(e ) $ OOO
(E) $5 ,000
Page32
required reserves or initial amount
required reserve ratio
=
bank deposits or ending amount
.ft5000-\\ F>')O::.
'
LI. u
·4-1,
,OOO
The Banks-Questions
9. Which of the following i a determinant of the
amount of money the cornrnercial banking y tern
can create?
(A
B
C
(D
(E
The rnarginal propen ity to con urne
The marginal propen ity to ave
The total number of bank
The ize of the federal debt
The re erve requirement
19. A bank ha $ 00 milli n in demand d p it and
$100 rnilli n in r rv . If the re, er er quir 1n nt
i l Op re nt th bank
(A)
(B
(C
$10 million
$20 milli n
$ 0 million
(D) $100 milli n
(E $200 milli n
Page33
x
r
r ·
qual
The Banks-Questions
9. Which of the following i a determinant of the
amount of money the cornrnercial banking y tern
can create?
(A
B
C
(D
(.
The rnarginal propen ity to con urne
The marginal propen ity to ave
The total number of bank
The ize of the federal debt
The re erve requirement
19. A bank ha $ 00 milli n in demand d p it and
$100 rnilli n in r rv . If the re, er er quir 1n nt
i IO p re nt th bank
x
r r · qual
(A) $10 million
•
$20 milli n
(C $ 0 million
(D) $100 milli n
(E $200 milli n
Page34
i'800
rn -,<. \ 0 °/o
I,
~ Sl),n