Download Chapter 27: Money, Banking, and the Financial Sector

Chapter 27: The Financial Sector and the Demand for Money
Chapter 27: The Financial Sector and the Demand for Money
Questions for Thought and Review
2.
Loanable funds are financial assets available for lending and borrowing.
4.
If the interest rate is higher than the rate that would equilibrate the supply and demand for
loanable funds, the supply of loanable funds will exceed the demand and there will be too
little investment.
6.
Money doesn't have to have any inherent value to function as a medium of exchange. All
that's necessary is that everyone believes that other people will accept it in exchange for
their goods. This is the social convention that gives money value.
8.
Money serves as a unit of account when people compare prices.
10.
Two components of M2 that are not components of M1 are savings deposits and smalldenomination time deposits.
12.
The equation for the simple money multiplier is 1/r; the equation for the multiplier is (1 +
c)/(r + c). Since c is positive, the simple multiplier is larger than the multiplier.
14.
People will increase the amount of money they hold, and sell bonds, if they expect
interest rates to rise in the future because the price of those bonds will be falling.
16.
The demand for money is downward sloping because the interest rate reflects the
opportunity cost of holding money. The higher the interest rate, the higher the
opportunity cost of holding money. So, people hold less of it when its cost rises.
Chapter 27: Problems and Exercises
18. a. money b. not money
g. not money
c. not money
d. not money
e. money
f. not money
20. a. No because they are hard to move. In this case, pearl shells were used for small
transactions.
b. It would lower the value of the stones, causing a general inflation in prices.
c. If they could be distinguished, which in this case they could, the new stones would sell at
a discount to the older stones, which they did.
d. Yes, in some ways money is a marker of individuals’ “gifts to the marketplace.”
22. a. Neither
24.
a.
b.
c.
d.
b. Both
c. M2
d. Both
e. Neither
f. Neither
g. Both
For a deposit of $100 and a reserve ratio of 5 percent,
The bank can lend out $95.
There is now an additional $195 in the economy.
The multiplier is 20.
John’s $100 will ultimately turn into $2,000.
26. a. If individuals hold no cash, the simple money multiplier is the reciprocal of the reserve
requirement. Thus for the following reserve requirements the simple multiplier is found
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Chapter 27: The Financial Sector and the Demand for Money
by dividing the requirement percentage into 1: 5%, 20; 10%, 10; 20%, 5; 25%, 4; 50%, 2;
75%, 1.33; 100%, 1.
b. If the ratio of currency individuals hold to their deposits is 20%, the multiplier becomes
(1+c)/(r + c) and so for the following reserve ratios their multipliers are now: 5%, 4.8;
10%, 4.0; 20%, 3.0; 25%, 2.67; 50%, 1.71; 75%, 1.26; 100%, 1.
Chapter 27: Web Questions
2. a. There is about $820 billion of U.S. currency in circulation today but most of it resides
outside of the U.S. Assuming that the world population is about 6 billion, this means that
there is approximately $137 per person in the world.
b. People typically withdraw cash at ATMs over the weekend, so there is more cash in
circulation on Monday than on Friday.
c. 1.8 years.
d. Most of this is in the form of U.S. government securities owned by the Federal Reserve
System. Some of it also consists of gold certificates, special drawing rights, and
“eligible” paper such as bills of exchange or promissory notes.
e. Bureau of Engraving and Printing.
Chapter 27: Appendix A
2.
It is a financial asset because it has value due to an offsetting liability of the Federal
Reserve Bank.
4.
No, she is not correct. While a loan is a loan, that loan is a financial asset to the one
issuing the loan because it has value just as a bond does.
6.
$0.50
8. a. Market rates are likely to be above 10 percent because the price of the bond is below face
value.
b. Its yield is 12.24 percent.
c. Its price would rise.
10.
Substituting into the present value formula PV = $1,060/1.1, we find that the bond is
worth $964 now.
12.
Using the present-value table, we see that at a 3 percent interest rate, $1 30 years from
now would be worth $0.41 now, so $200 in 30 years would be worth $82 now.
14.
If the interest rate is still 9 percent, the value of a lump sum of $20,000 in 10 years can be
calculated using the annuity table in Table A27-1. You should be willing to pay $20,000
X 0.42, or about $8,400 for this offer.
16. a. Agree/Disagree. Technically, a rise in stock prices does not imply a richer economy. If,
however, the rise in stock prices reflects underlying real economic improvement such as
finding the cure for cancer or a technological advance, society will be richer not because
of the rise in stock prices, but because of the underlying cause of their rise.
b. Disagree. If both the real and financial asset are worth $1 million, then they have the
same value as long as they are valued at market prices. Just as financial assets bear a risk
of no repayment, real assets bear a risk of a fluctuation in prices.
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Chapter 27: The Financial Sector and the Demand for Money
c. Disagree. Although financial assets do not have a corresponding liability, they facilitate
trades that could not otherwise have taken place and thus have enormous value to society.
d. Disagree. The value of an asset depends not only on the quantity but also on its price per
unit. The price of land per acre in Japan exceeds that in the United States by so much that
the total value of land in Japan also exceeds that in the United States.
e. Disagree. The stock market valuation depends on the supply and demand for existing
stock. There is, however, a relationship between relative growth in GDP and the rise in
stock prices to the extent that growth in stock prices and GDP growth both reflect
economic well-being in a country. Also, many of the companies are multinational
companies, and where the company is based may not reflect where its value added is
generated.
Chapter 27: Appendix B
2. a.
The effect on the balance sheet is shown below:
Assets
Liabilities
Cash
$10,000
Demand deposits $50,000
-1,000
-1,000
9,000
49,000
Loans
100,000
Net worth
110,000
Physical assets 50,000
Total assets $159,000
Total liabilities and
net worth
$159,000
b. The reserve ratio is now 18 percent. This is less than the required 20 percent. The bank
must decrease loans by $800 to meet the reserve requirement. But this shows up as $800
less in demand deposits and $800 less in cash. The bank must again reduce loans, but this
time by $640. Demand deposits once again decline. This continues until the final position
indicated by the following T-account:
Assets
Liabilities
Cash
$ 9,000
Demand deposits $ 45,000
Loans
96,000
Net worth
110,000
Physical assets 50,000
Total assets $155,000
Total liabilities and
net worth
$155,000
c. The money multiplier is 5.
d. Total money supply declined by $5,000.
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