BEC 7 - Macroeconomics 3 - Price Levels/Monetary Policy

Question 1

The controller of Gray, Inc. has decided to use ratio analysis to analyze business cycles for the past two years in an effort to identify seasonal patterns. Which of the following formulas should be used to compute percentage changes for account balances for year 1 to year 2?
A. (Prior balance - current balance) / current balance.
B. (Prior balance - current balance) / prior balance.
C. (Current balance - prior balance) / current balance.
D. (Current balance - prior balance) / prior balance.

Answer 1

D. The correct formula to compute the percentage changes for account balances is (Current balance - prior balance) / prior balance. The numerator computes the change in amount from the prior year balance to the current year balance and the use of the prior year’s balance in the denominator determines the percentage change from the prior year’s balance.

Question 2

Define “price indexes (or indices)”.

Answer 2

Factor that converts prices of each period to what those prices would be in terms of prices of a specific prior (or subsequent) reference period.

Question 3

Identify three common price indices.

Answer 3

1. Consumer Price Index (CPI);
2. Wholesale Price Index (WPI);
3. Gross Domestic Product (GDP) Deflator.

Question 4

What are the consequences of inflation?

Answer 4

1. Lower current wealth and lower future real income;
2. Higher interest rates;
3. Uncertainty of economic measures.

Question 5

What causes demand-induced (or demand-pull) inflation?

Answer 5

Results when aggregate spending for goods and services exceeds the productive capacity of the economy at full employment.

Question 6

T/F: US currency is backed by gold.

Answer 6

False.
US paper currency takes the form of Federal Reserve notes, which have no value without the good faith and credit of the US gvmt.

Question 7

The Federal Reserve System’s reserve ratio is

Answer 7

The reserve ratio is the percentage of total checking deposits that a financial institution must hold on reserve in the central bank.

Question 8

What are the methods used by the Federal Reserve to regulate the money supply?

Answer 8

1. Reserve-requirement changes (percent of loan amounts that must be held by bank);
2. Open-Market Operations (buying and selling U.S. Treasury debt obligations);
3. Discount Rate (rate of interest banks pay when borrowing from Federal Reserve Banks).

Question 9

Define “monetary policy”.

Answer 9

Management of the money supply so as to achieve national economic objectives (e.g., economic growth and price level stability).

Question 10

Identify and define the various measures of money used by the Federal Reserve.

Answer 10

1. M1: Paper and coin currency held outside banks and check-writing deposits.
2. M2: Includes M1 items plus savings deposits, money-market deposit accounts, certificates of deposit (less than $100,000), individual-owned money-market mutual funds, and certain other deposits.
3. M3: Includes M2 items plus certificates of deposit ($100,000 and greater), institutional-owned money-market mutual funds, and certain other deposits.

Question 11

Identify the major components of the United States banking system, the Federal Reserve System.

Answer 11

1. Reserve-requirement changes (percent of loan amounts that must be held by bank);
2. Open-Market Operations (buying and selling U.S. Treasury debt obligations);
3. Discount Rate (rate of interest banks pay when borrowing from Federal Reserve Banks).