Econ 201
HW 4
Money and Banking
1. Why is there a trade-off between liquidity and the return on money?
2. (a) If the U. S. used commodity money (gold, for example), what happens to the price level if the
economy grows but the money supply does not? Explain your answer.
(b) What happens to the price level if the money supply increases but the economy does not
grow? Explain your answer.
3. The required reserve ratio is 0.1. Assuming banks have no desire to hold excess reserves,
a. Calculate the simple deposit multiplier.
b. If reserves are increased by $200,000, will the money supply increase or decrease, and
by how much?
4. Use the simple balance sheet below to answer the following questions: (6)
Assets
Liabilities
Reserves
$10,000
Deposits
$50,000
Loans
$45,000
Capital
$30,000
Securities (Bonds)
$45,000
Debt
$20,000
a.
Assume the bank has no desire to hold excess reserves. Find the required reserve
ratio.
b.
If the government buys $10,000 worth of bonds from the bank, complete the new
balance sheet. Assume the bank does not hold excess reserves.
Assets
Liabilities
Reserves
Deposits
Loans
Capital
Securities (Bonds)
Debt
c.
Assume the required reserve ratio is the same as in (a). Find the change in the money
supply.
5. Use the graph below to answer the questions.
a.
Label the money supply and money demand curves.
b.
If the interest rate is 5%, how much money will people wish to hold?
c.
If the interest rate is 5%, how much money will be supplied?
d.
Will banks wish to raise or lower interest rates if the rate is currently 5%?
e.
What are the equilibrium interest rate and quantity of money balances?
6. A bank has $100,000 in deposits. It currently holds $60,000 in reserves.
a.
If the required reserve ratio is 15%, find the bank’s required reserves and its excess
reserves.
b.
Why might a bank choose to hold excess reserves, given that excess reserves will not
earn profit? (In this example, we are assuming that the Fed is not paying interest on
reserves.)
7. The FDIC insures individual bank deposits up to a certain amount. What are the benefits and
costs of such a policy? (Hint: consider moral hazard)
Monetary Policy
8. What will happen to the interest rates banks charge businesses and consumers if the federal
funds rate falls? Explain your answer.
9. If equilibrium real GDP is less than full employment real GDP, what should the Fed do
(a) About the discount rate?
(b) The reserve requirement?
(c) With bonds?
(d) About interest payments the Fed offers on bank reserves? (Assume the Fed
currently pays interest on bank reserves.)
10. The Fed is worried about inflation. The Fed will respond by increasing/decreasing the money
supply/money demand? (Circle the appropriate answers.)
Draw the appropriate change on the graph below.
Equilibrium interest rates will increase/decrease.
The quantity of money people will hold will increase/decrease.
11. Consider how the scenario in the previous question will affect the market for loanable funds.
Draw the appropriate changes on the graph, and circle the appropriate answers in the
statements below.
Equilibrium interest rates will increase/decrease.
The quantity of investment spending will increase/decrease.
12. Consider how these changes will affect the real economy. Draw the appropriate changes on the
graph, and circle the appropriate answers in the statements below.
The price level will increase/decrease.
Real GDP will increase/decrease.
13. Based on your answers above, as inflation falls, unemployment will __________.
14. The Fed may sometimes “closes the discount window,” suspend lending to member banks.
What effect would this have on the federal funds rate? How would this affect the money
supply? What affect would this have on real GDP and the price level? Explain your answers.
15. On the graph below, we assume that the money demand curve flattens out when interest rates
get very low. What will happen to interest rates if the Fed increases the money supply? Will
monetary policy be effective at increasing aggregate demand under these circumstances?
Explain.
16. The simple deposit multiplier is calculated as 1/(required reserve ratio). This assumes that banks
will not hold any excess reserves. What happens to the multiplier if banks decide to hold excess
reserves? Explain.
Phillips Curve
17. (a) If the inflation rate increases in the short run, the unemployment rate will___________ in
the short run.
(b) If the inflation rate increases in the long run, the unemployment rate will _________ in the long
run.
18. Which of these represents a short run Phillips curve and which is the long run? Explain.
19. Assume the Phillips curve below applies to the economy in the short run.
a) If the economy is currently at point B, the inflation rate is ____________ and the unemployment
rate is __________.
b) If the central bank wants to move the economy from point B to point A, it will reduce inflation
by _________ but increase unemployment by __________.
c) The central bank should increase/decrease the money supply. It should buy/sell government
bonds, raise/lower reserve requirements, and raise/lower interest rates.
d) The economy will experience deflation when the unemployment rate rises above:
e) Assume the natural rate of unemployment in this economy is 4%. Draw the long run Phillips
curve on the graph.
f) If the natural rate of unemployment is 4%, and the economy is currently at point A. is the
economy experiencing an inflationary gap, a recessionary gap, or neither? Explain.
20. For the scenarios below:
a. The Fed consistently adopts significant expansionary monetary policy.
(i) If the economy is initially at point ‘A’, we need to increase/decrease inflation to return the
economy to full employment.
(ii) Draw the shift, if any, in the short run Phillips Curve in response to the scenario above.
(iii) After the shift (if there is one), it will take a greater/lower/the same level of inflation to return
the economy to full employment.
(c) The Fed announces a disinflation policy, but no one believes them.
(i) If the economy is initially at point ‘C’, we need to increase/decrease inflation to return the
economy to full employment.
(ii) Draw the shift, if any, in the short run Phillips Curve in response to the scenario above.
(iii) After the shift (if there is one), it will take a greater/lower/the same level of inflation to return
the economy to full employment.
21. Adaptive expectations are different than the rational expectations model discussed in the text.
Adaptive expectations are formed based on past experience, not large amounts of information.
Which of the following shows adaptive expectations? Which shows rational expectations?
Explain.
a. Marcus examines government-published data to determine whether to adjust his prices
for the next month.
b. Inflation has been relatively low, so Lucinda doesn’t really worry about increasing the
prices she charges.
International Trade
22. Based on the graph below, draw the line corresponding to the world price on the country graph.
Complete the table.
World Equilibrium Price
World Equilibrium Quantity
Domestic Equilibrium Price
Domestic Equilibrium Quantity
World Price
Export or Import?
Quantity of Exports/Imports
Quantity Produced Domestically
Quantity Consumed Domestically
23. Assume a country currently allows free trade. The country is currently a net importer of good x.
The government wants to export good x. Which of the following is the best way to accomplish
this? Explain your answer.
a. Tariff on imports
b. Subsidizing domestic producers
c. Tax rebates to domestic consumers who purchase the good.
24. Use the supply and demand data to complete the table. Complete the no-trade outcome.
Assume the world price of the good is $10. Complete the “With Free Trade” column. Then
assume the government imposes a 50% tariff and complete the relevant column. Graph supply
and demand. Graph the world price. Graph the tariff.
Price
Quantity Demanded
Quantity Supplied
$5
5000
800
10
4000
1200
15
3000
1600
20
2000
2000
25
1000
2400
30
500
3000
Without
Trade
With Free
Trade
With 50%
tariff
Price
Quantity Consumed Domestically
Quantity Produced Domestically
Import/Export/Neither
Quantity Imported/Exported
Tax Revenue From Tariff
$
Quantity
Exchange Rates
25. For each of the following,
(i)Draw the appropriate curve shift.
(ii) Explain your decision.
(iii) State what will happen to the equilibrium exchange rate.
(iv)State what will happen to the equilibrium quantity of $ exchanged.
(v) State what will happen to the quantity of exports.
(vi) State what will happen to the quantity of imports.
a. Demand for U. S. goods in Europe decreases.
b. The Fed increases the money supply.
26. The European Central Bank is worried that the Fed is increasing the money supply. If the ECB
wishes to protect exports from the European Union, it should _______________ dollars and
___________ Euros. Explain how this would help.
27. Use the data below to complete the table and graph the demand for dollars in the foreign
exchange market. Assume the price of the good below is $20.
Price in €
Quantity of exports
Exchange Rate (€/$)* $ Demanded
demanded
500
.25
400
.5
300
.75
200
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