Module 8

Question 1

Barter

Answer 1

To exchange goods or services for other goods or services without the use of money.

Question 2

Double coincidence of wants

Answer 2

PROBLEM (barter): it takes time and resources for barter and trade to happen.

Question 3

Commodity money

Answer 3

Is a good used as money, but also has an intrinsic value (e.g. gold).

Question 4

Problem with commodity money

Answer 4

Difficult to control the supply of money (e.g. a new discovery) and to carry around.

Question 5

Fiat money

Answer 5

Paper currency that is authorized by a central bank, but not backed by gold.

Question 6

Problem with fiat money

Answer 6

Expectations: households and firms have confidence in the value of currency.

Question 7

Medium of exchange

Answer 7

(Function #1): buyers and sellers are willing to accept it (legal tender).

Question 8

Unit of account

Answer 8

(Function #2): a way of measuring value in the economy in terms of money.
ADVANTAGE: standardized money creates efficiency by valuing each good in dollars.

Question 9

Store of value

Answer 9

(Function #3) A way to hold savings for future use.

Question 10

Standard of deferred payment

Answer 10

It facilitates borrowing and lending over time.
DISADVANTAGE: Because of inflation, it loses purchasing power over time.
ADVANTAGE: It is easy to convert to a medium of exchange (liquidity)

Question 11

Money is a stock

Answer 11

value of currency and value of deposits. Banks can create money by loaning out reserves in excess of the required reserves (RR).

Question 12

Required Reserves

Answer 12

A bank is legally required to hold them, based on its deposits.

Question 13

The simple deposit multiplier

Answer 13

1/RR

Question 14

Change in checking account deposit.

Answer 14

= change in bank reserves * (1/RR)

Question 15

Overall change in money supply

Answer 15

= increase in deposits - decline in currency

Question 16

Open market operations (decided by the federal open market committee)

Answer 16

The trading desk purchases Treasury securities to increase the money supply: the sellers of securities deposit the funds -> increases loans -> increases reserves.

Question 17

Discount policy

Answer 17

the reason for which the Federal Reserve was established.

Question 18

Discount Rate

Answer 18

The interest rate the bank pays when borrowing from the fed.
The fed lowers the discount rate -> increases the money supply: banks borrow more -> increases reserves -> increases loans.

Question 19

Lender of last resort

Answer 19

The Fed can act as a lender of last resort in case of a run on the banks (1930s).

Question 20

Reserve Requirements (seldom changed by the Federal Reserve)

Answer 20

The Fed reduces the required reserves ratio -> increases the money supply: banks convert required reserves into excess reserves -> increases loans.

Question 21

The money demand

Answer 21

Ceteris paribus, it shows the negative relationship between the interest rate (i) and the quantity of money (m) held by households and firms.

Question 22

Why is the money demand curve negative

Answer 22

The negative slope results from the choice of households and firms holding money and holding treasury bills.
ADVANTAGE OF HOLDING MONEY: it can be used to buy goods and services (liquidity).
DISADVANTAGES OF HOLDING MONEY: it does not earn interests (opportunity cost).

Question 23

Shifts in demand for money

Answer 23

An increase in real GDP (Y) -> The demand for money shifts right.
An increase in price level (P) -> The demand for money shifts right.

Question 24

The equilibrium in the money market

Answer 24

Ms = Md: households and firms hold the desired amount of money given the equilibrium interest rate.