Week six learning

Question 1

What is the main problem with barter?

Answer 1

It requires a double coincidence of wants (both parties need to have what the other wants) and wastes resources on searching for trading partners.

Question 2

What is money?

Answer 2

A set of assets in an economy that people use regularly to buy goods and services.

Question 3

What are the three functions of money?

Answer 3

Medium of exchange
Unit of account
Store of value

Question 4

What does medium of exchange mean?

Answer 4

It is an item that buyers give to sellers when purchasing goods and services.

Question 5

What does unit of account mean?

Answer 5

It is a yardstick people use to post prices and record debts.

Question 6

What does store of value mean?

Answer 6

It is the ability to transfer purchasing power from the present to the future

Question 7

What is liquidity?

Answer 7

The ease with which an asset can be converted into the economy’s medium of exchange.

Question 8

What are commodity money and fiat money?

Answer 8

Commodity money: Money with intrinsic value (e.g., gold, silver).
Fiat money: Money with value because of government decree (e.g., coins, currency).

Question 9

What is the money supply?

Answer 9

The quantity of money available in the economy.

Question 10

What are the measures of the money supply in New Zealand?

Answer 10

M0: Monetary base (physical currency + settlement cash balances)
M2: Broad money (98% is bank deposits)

Question 11

What is the role of the Reserve Bank of New Zealand (RBNZ)?

Answer 11

The RBNZ manages price stability, keeping inflation between 1% and 3% over the medium term.

Question 12

How does the Official Cash Rate (OCR) affect the economy?

Answer 12

It influences short-term interest rates, affecting borrowing costs and demand in the economy. A higher OCR reduces borrowing and demand, lowering inflation.

Question 13

Why is the amount of money (M2) in the system much greater than the amount of cash?

Answer 13

Because banks create money through fractional-reserve banking by holding a fraction of deposits in reserve and lending out the rest.

Question 14

What are reserves in banking?

Answer 14

Deposits that banks have received but have not loaned out. In a fractional-reserve system, banks hold a portion as reserves and lend out the rest.

Question 15

What is the money multiplier (M)?

Answer 15

M is the reciprocal of the reserve ratio (R). For example, with a reserve ratio of 10%, M = 1/0.10 = 10.

Question 16

What is the maximum amount the money supply could increase if a $50 deposit is made with a reserve ratio of 10%?

Answer 16

The maximum increase is $450. (Money multiplier M = 10, so 10 x $50 = $500, increase = $500 - $50 deposit = $450)

Question 17

What is the maximum amount the money supply could increase if a $50 deposit is made with a reserve ratio of 5%?

Answer 17

The maximum increase is $950. (Money multiplier M = 20, so 20 x $50 = $1000, increase = $1000 - $50 deposit = $950)

Question 18

What are the components of a bank’s balance sheet?

Answer 18

Assets (reserves, loans, securities) and liabilities (deposits, debt, equity). Bank capital is the difference between assets and liabilities.

Question 19

What is the leverage ratio in banking?

Answer 19

The ratio of total bank assets to bank capital. For example, $1000 in assets with $50 in capital gives a leverage ratio of 20.

Question 20

How did the financial crisis of 2008–09 impact banks?

Answer 20

Many banks faced a capital shortage due to losses on mortgage loans, leading to reduced lending and a credit crunch, which worsened the economic downturn.