week 1: history of financial crisis

Question 1

Why was the federal reserve system established?

Answer 1

in response to the banking crisis

Question 2

1989: there were _____ bank failures.

Answer 2

534

Question 3

2010: ____ bank failures

Answer 3

157

Question 4

difference between 1989 vs 2010 bank failures

Answer 4

In 1989, many banks that failed were small

But in 2010, some very large banks failed.

Question 5

when was BLACK MONDAY?

Answer 5

19th Oct 1987

Question 6

what happened on black monday? ‘87

Answer 6

One of the most significant stock market crashes in history.

stock market bubble crashed

Question 7

what happened in asian financial crises (late 1990s)

Answer 7

For a v. short period time, all of these Asian currencies collapsed:

Indonesia
Malaysia
Thailand
Korea
Phillipines

Question 8

What is Barter?

Answer 8

Barter is the exchange of goods + services for other g+s

Question 9

What is the main problem with bartering?

Answer 9

It requires a double coincidence of wants

i.e., if I want an apple for an orange, I first must find someone who wants an orange AND is selling an apple

Question 10

Barter also requires the establishment of __________________

Answer 10

Too many prices.

e.g., if we have $n$ goods, we could have up to $n(n-1)/2$ prices.

Question 11

How does n(n-1)/2 work?

Answer 11

In a barter system, goods are directly exchanged for other goods without using money. Now, imagine you have
𝑛 different types of goods available for exchange.

To establish fair exchange rates between all these goods, you need to determine the relative value of each good compared to every other good. For example, if you have 3 goods (let’s call them A, B, and C), you need to establish the exchange rates for A:B, A:C, and B:C.

For n goods, the number of possible pairwise exchanges (exchange rates) can be calculated using the formula:

Number of pairwise exchanges
= 𝑛(𝑛− 1 )/2

Let’s break down the formula:

n represents the number of different types of goods available.

(𝑛 − 1) represents the number of other goods each good needs to be compared with (excluding itself).
Dividing by 2 eliminates double counting because the exchange rate for A:B is the same as B:A.
For example, if you have 4 goods, the number of pairwise exchanges needed would be:

[4×(4−1)]/2
= (4×3)/2
=12/2
=6

So, in a barter system with 4 goods, you would need to establish 6 different exchange rates to facilitate trading efficiently.

As the number of goods increases, the number of pairwise exchanges (and thus the number of prices that need to be established) grows rapidly, making the barter system increasingly complex and impractical compared to using a single standardised medium of exchange like money.

Question 12

what is the diagram of monetary exchange of establishment of too many prices

Answer 12

Question 13

what’s the solution to having too many prices?

Answer 13

To establish a generally accepted commodity as a medium of exchange that also serves as the unit of account (numeraire)

Question 14

As long as all parties agree to the arrangement, then the seller only needs to find someone ____________ + is in possession _____________.

Answer 14

seller only needs to find someone willing to buy their goods + is in possession of the medium of exchange

Question 15

having an accepted commodity of exchange means that only ___ prices are needed

Answer 15

n -1

Question 16

over time, many ____________ used as a medium of exchange

Answer 16

commodities
e.g. shells, stone, copper

Question 17

later… commodities were substituted by _________________ issued by _________ and more recently, _____________

Answer 17

Later, commodities substituted by pieces of paper (fiat currency) issued by the central bank & more recently, electronic transfers

Question 18

How did direct finance: bilateral exchange develop?

Answer 18

in ancient societies, natural disasters could cause disastrous effects on household consumption patterns, so:

a system of credit was developed to mitigate bad effects

– Fortunate households lent their surplus foods to affected households, expecting that the poor household would reciprocate in the future when fortunes may be reversed

Question 19

What was invented to keep accounts of who owes whom?

Answer 19

System of tallies

Question 20

What is direct finance thru bilateral exchange?

Answer 20

Direct finance through bilateral exchange simply refers to the direct exchange of goods or services between two parties without the involvement of any intermediaries such as banks or financial institutions.

In simple terms, it’s like when you and a friend swap items or services directly. For example, if you trade your skateboard for your friend’s video game console, that’s a form of direct finance through bilateral exchange. There’s no need for money or any third party; it’s just a direct exchange between the two of you.

Question 21

What is direct finance through markets?

Answer 21

In Modern Societies, organized markets allow more efficient ways for bringing together borrowers & lenders.

Question 22

What do participants trade in the stock markets?

Answer 22

Participants trade corporate ownership shares

Question 23

The holder of a corporate ownership share is entitled to —?

Answer 23

Holder is entitled to a proportional share of profits + losses of the issuing firm (equity contracts)

Question 24

What is equity?

Answer 24

A proportion of profits

Question 25

Direct finance is suitable for what kind of firms?

Answer 25

large & old firms that have established good reputation in the market.

Question 26

Indirect finance [thru banks] is suitable for what kind of firm?

Answer 26

Small firms & households who need to borrow funds but lack credentials to borrow from market.

Question 27

what do banks offer to households + firms that want to postpone spending?

Answer 27

Deposits

Question 28

Who do banks offer loans to?

Answer 28

Households + firms that wish to postpone spending but don’t have the funds

Question 29

The ______ ______ shows what a bank owns (assets) and what it owes (liabilities)

Answer 29

Balance Sheet

Question 30

what are assets + liabilities of a bank?

Answer 30

1. assets are what the bank owns
2. liabilities are what the bank owes

Question 31

Equity is …?

Answer 31

Equity is what is owed to the owners

Question 32

If equity is positive/negative the bank is…?

Answer 32

1. Equity POSITIVE bank SOLVENT
2. Equity NEGATIVE bank INSOLVENT

Question 33

If the left hand side is enough to cover the ________, the bank is ________

Answer 33

If left hand side is enough to cover the deposits, the bank is solvent

Question 34

What is autarky?

Answer 34

An economy that is self sufficient (closed economy)

Question 35

The benefits of specialisation can be enhanced by …?

Answer 35

Allowing exchange of goods + services across national borders. (Theory of comparative advantage)

This is international trade

Question 36

Similarly, allowing _____ to flow across national borders ______ ___________

Answer 36

Allowing capital to flow across national borders expands borrowing and lending opportunities

These are international capital flows

Question 37

Draw the market for $ diagram

Answer 37

Question 38

When currencies are freely traed, the determinant for exchange rates is the…?

Answer 38

Market