Chapter 10

Question 1

What is money?

Answer 1

Money is anything that is generally accepted as a medium of exchange

Question 2

What are the properties of money?

Answer 2

• General acceptability- must be accepted by everyone
• Durability- should be durable and not lose its value when passed around
• Portability
• Homogeneity and divisibility- should be made of the same material
• Recognisable
• Stable value
• Relative scarce

Question 3

What is the function of money?

Answer 3

• Medium of exchange - for buying and selling of goods and services and escaping the complications of a barter system
• Unit of account - SA rands measure the relative worth of goods
• Store of value- enables people to transfer the purchasing power of goods to the future.

Question 4

What is the M0 money format?

Answer 4

M0 are coins and banknotes in circulation

Question 5

What is the M1A money format?

Answer 5

M1A are coins, banknotes cheques and transmission deposits

Question 6

What is the M1 money format?

Answer 6

M1 consists of M1A and all other demand deposits

Question 7

What is the M2 money format?

Answer 7

M2 consists of M1 and all short and medium-term deposits

Question 8

What is the M3 money format?

Answer 8

M3 consists of M2 and plus all long-term deposits

Question 9

What is the demand for money?

Answer 9

• Transaction demand for money, Dt
• Asset demand, Da
• Total money Demanded Dm-

Question 10

What is transaction demand for money?

Answer 10

Transaction demand for money, Dt - is by households (C) who use money as a medium of exchange for purchasing goods and precautionary demand ensures a backup of funds to pay for emergencies. The Main determinant is GDP.

Question 11

What is the asset demand?

Answer 11

Asset demand, Da - Money is the most liquid form of all financial assets in asset demand. Households may hold their financial assets and these function of money as stores of value money.

Question 12

What is the total demand?

Answer 12

Total money Demanded Dm- by horizontally adding the assets demand and precautionary demand

Question 13

How does transaction demand relate to GDP?

Answer 13

The transactions and precautionary demand for money vary directly with GDP.

Question 14

How does the asset amount of money relate to the rate of intrest?

Answer 14

The amount of money demanded as an asset varies inversely with the rate of interest. When the interest rate rises, being liquid and avoiding capital losses becomes more costly.

Question 15

What are the advantages and disadvantages of assets?

Answer 15

• Advantage of money as an asset: liquidity; when the price of bonds falls;
• Disadvantage of money as an asset: no or very little interest.

Question 16

How does the transaction demand for money graph look?

Answer 16

Transactions demand for money is vertical because it depends on nominal GDP rather than real interest rates (i)

Question 17

How does the assets demand money graph look?

Answer 17

Assets demand money is a downward slope as it varies inversely with the interest rate because of the opportunity cost involved in holding currency/cheque deposits with low or no interests

Question 18

How does a demand for money graph look?

Answer 18

The demand for money graph is negatively slopped showing there is an inverse relationship between the rate of interest and the amount of money demanded

Question 19

How does a money supply curve look?

Answer 19

Money supply curves have a vertical line as they are fixed. Monetary authorities and financial institutions have provided the economy with a particular stock of money.

Question 20

How does a supply curve relate to interest rate?

Answer 20

An increase in the supply of money will lower the equilibrium interest rate, a decrease will lower the equilibrium interest rate

Question 21

How is the rate of intrest found?

Answer 21

The rate of interest in the economy is found at the equilibrium between the total supply of money and the total demand for money.

Question 22

What is the relationship between interest rates and bond prices?

Answer 22

There is an inverse relationship between interest rates and bond prices. Bond prices fall when interest rates rise and bond prices rise when interest rate falls.

Question 23

What is the SARB?

Answer 23

South African Reserve Bank (SARB) is responsible for the monetary policy in the country

Question 24

What are the three tools of monetary policy?

Answer 24

Tools of monetary policy:
- Open market operations - buying and selling of bonds between the reserve bank and commercial banks
- The reserve ratio- the percentage of money held in reserve
- The repo rate- the rate of interest the reserve bank charges to commercial banks

Question 25

How does the open market increase or decrease the money supply?

Answer 25

- When bonds are bought from commercial banks the money supply increases, and interest rate will decrease. It will make borrowing cheaper and consumers will purchase more shifting the aggregate demand curve to the rights. This decreases prices and this targets inflation - When the bonds are sold to the commercial bank the money supply will decrease and the interest rate will increase. It will make borrowing more expensive, decreasing consumption, and the aggregate demand curve will shift to the left. This increases prices and targets unemployment/recession

Question 26

How does the reserve ratio increase or decrease the money supply?

Answer 26

- A decrease in the reserve ratio will make borrowing cheaper as more money can be loaned out to the public - An increase in the reserve ratio will make borrowing more expensive as less money can be loaned out

Question 27

What is a reserve ratio?

Answer 27

Every time we deposit money into a bank that money has to hold a certain percentage in reserve this is the reserve ratio.

Question 28

What is the repo rate?

Answer 28

The repo rate is the amount charged to commercial banks when they borrow money from the reserve bank. It directly affects the prime interest rate.

Question 29

How does the repo rate increase or decrease the money supply?

Answer 29

- An increase in the repo rate will decrease the money supply, as the prime interest rate will increase and the cost of borrowing will decrease so consumption will decrease. Prices will decrease and the aggregate demand curve will shift to the left. This targets inflation - An decrease in the repo rate will increase the money supply, as the prime interest rate will decrease and the cost of borrowing will increase so consumption will increase. Prices will increase and the aggregate demand curve will shift to the right.

Question 30

What does a shift in the money supply do to the real interest rate?

Answer 30

If the money supply increases the equilibrium shifts to the right and the real interest rate decreases. The more money in the economy that is available to borrow the real interest decreases

Question 31

What will the expansionary monetary policy do?

Answer 31

Expansionary monetary policy aims to stimulate economic growth and decrease unemployment. The monetary policy tools will increase the money supply and decrease the interest rate, making money cheaper.

Question 32

How does expansionary monetary policy affect the open market operations?

Answer 32

Open market operations -The reserve bank will buy bonds from the commercial banks. The Money supply will increase and the interest rate will decrease

Question 33

How does expansionary monetary policy affect the reserve ratio?

Answer 33

The reserve ratio - The reserve bank will decrease the reserve ratio. Allowing commercial banks to lend more to the public, the money supply increases. More borrowing means more spending, and more economic growth which will decrease unemployment

Question 34

How does expansionary monetary policy affect the repo rate?

Answer 34

Repo rate - The reserve bank lowers the repo rate. Commercial bank's prime rate will decrease, and borrowing will increase. Increase money supply and spending

Question 35

What will the contractionary monetary policy do?

Answer 35

Contractionary monetary policies are when the economy focuses on rising inflation. The main tool used to target inflation is the repo rate. The aim is to decrease the money supply and increase the interest rate. This is to increase spending and therefore prices

Question 36

How does contractionary monetary policy affect the open market operations?

Answer 36

Open market operations - Reserve bank sells bonds to commercial banks. The money supply decreases the commercial bank has less money to lend and the cost of borrowing increases. People borrow less and spend less, aggregate demand decreases and prices decrease

Question 37

How does contractionary monetary policy affect the reserve ratio?

Answer 37

The reserve ratio - the reserve bank increases the reserve ratio. Commercial banks will hold more reserves and lend out less. Decreases the money supply and increases interest rate. People borrow less and spend less and therefore prices decrease

Question 38

How does contractionary monetary policy affect the repo rate?

Answer 38

Repo rate - The reserve bank increases the repo rate. Commercial bank's prime rate will increase, increasing the cost of borrowing. Consumers borrow less and spend less, aggregate demand decreases and prices decrease