Banks

Question 1

What is money?

Answer 1

A medium of exchange used to purchase goods and services

Question 2

What does money allow to happen?

Answer 2

It allows purchasing power to be transferred among people

Question 3

What is required for money to work?

Answer 3

Everyone to trust that everyone else will accept money as payment

Question 4

What is M1?

Answer 4

Liquid wealth: money that is instantly available to be used for purchases (ie cash, coins, current accounts)

Question 5

What is the definition of income?

Answer 5

The amount of money one receives over some period of time

Question 6

What is the definition of wealth?

Answer 6

The stock of things owned, or the value of that stock

Question 7

What is depreciation?

Answer 7

The reduction in value of a stock or wealth over time

Question 8

What is net income?

Answer 8

The maximum amount that one could spend without running down wealth
Net income = gross income - depreciation

Question 9

What are earnings?

Answer 9

Wages, salaries, and other incomes from labour

Question 10

What are savings?

Answer 10

Savings are income that is not consumed

Question 11

What is economic investment?

Answer 11

Expenditure on newly produced capital goods, such as machinery

Question 12

What is the opportunity cost of having more goods?

Answer 12

Having more goods now comes with an opportunity cost of having fewer goods later

Question 13

What do borrowing and lending allow?

Answer 13

They allow for one to rearrange their capacity to buy goods and services across time

Question 14

What does borrowing allow?

Answer 14

More to be bought in the present at the expense of buying less in the future

Question 15

What is interest rate?

Answer 15

The interest rate on borrowing money is equal to the price of brining buying power forward in time

Question 16

What are the two factors that affect how much consumption an individual will move forward?

Answer 16

Consumption smoothing

Impatience

Question 17

Why does an individual smooth their consumption?

Answer 17

So they avoid spending a lot in one period then little in another period

Question 18

What is diminishing marginal returns to consumption?

Answer 18

The value of an additional unit of consumption declines, and depends on the consumption an individual has

Question 19

What are the actions of a saver?

Answer 19

They smooth their consumption by postponing it to the future

Question 20

What does lending money do?

Answer 20

Lending at interest expands the lenders feasible set as compared to just storing the money

Question 21

What does investment do?

Answer 21

Allows consumption to be moved to the future

Question 22

How can consumption be increased for both periods of high and low income?

Answer 22

By using a combination of both investing and borrowing money

Question 23

What does a balance sheet do?

Answer 23

Summarises what a firm owns and what it owes to other

Net worth = assets - liabilities

Question 24

What is a bank?

Answer 24

A firm that makes profit by borrowing and lending money

Question 25

Where do banks borrow from?

Answer 25

Households (through deposits), other banks, and the central bank

Question 26

How do banks make profit?

Answer 26

The interest they pay on the money they borrow is less than the interest they charge on money they lend, allowing them to make profit

Question 27

What is base money?

Answer 27

The physical money, such as cash and coins. It is legal tender, so has to be accepted as payment by law

Question 28

What is the central bank?

Answer 28

The banker for commercial banks, normally owned by the government, and the only bank in the country allowed to create legal tender

Question 29

How can the central bank create money?

Answer 29

All commercial banks have an account at the central bank, and by crediting these accounts, the central bank is able to create legal tender

Question 30

How do commercial banks create money?

Answer 30

They make loans by lending the money deposited into them, thus creating bank money, which is not legal tender

Question 31

What is broad money?

Answer 31

The combined total of all money, including bank money and base money
Broad money = base money + bank money

Question 32

What is a bank run?

Answer 32

A situation where all depositors demand their money at once. Bank runs can result in a bank failure, as there isn’t enough base money kept in a bank for this to happen.

Question 33

As well as a bank run, what is the other way that a bank can fail?

Answer 33

By making bad investments, such as giving loans that don’t get paid back

Question 34

Why may the government intervene when a bank fails?

Answer 34

A bank failure can bring down the financial market, such as in 2008

Question 35

Why do those with less wealth often find it hard to borrow money?

Answer 35

They can struggle to provide equity or collateral, as they have limited wealth

Question 36

What is credit rationing?

Answer 36

When those with less wealth:
Borrow on unfavourable terms compared to those borrowing with more wealth (credit-constrained)
Are refused loans completely (credit-excluded)