Economic homework

ECON 202 Drexel University

Assignment 4 Professor: María Pía Olivero NAME: _______________________________________________ MULTIPLE CHOICE SECTION (25 points, 5 points each) 1) If the minimum reserve requirement for all bank deposits is 25%, then the maximum multiple creation of deposits by the banking system as a whole following a cash deposit of $1,000 would be:

a) 100 b) 2100 c) 4000 d) 10,000

2) If the reserve requirement is 5%, then the maximum multiple creation would be:

a) smaller than in the previous question b) larger than in the previous question c) the same

3) If banks in the economy hold some financial investments other from loans and if the reserve requirement is 5%, the amount of money that can be created out of an initial deposit of $1,000 is: a) $20,000 b) $30,000 c) Bigger than $20,000 d) Smaller than $20,000

4) If there is cash hoarding in the economy, the maximum amount of money that can be created out of an initial deposit of D is: a) 1/m * D b) Less than that c) More than that d) It depends on the type of government spending the government is engaging in 5) I) The primary benefit of the medium of exchange function of money is that it makes exchange more efficient. II) A barter system imposes the need for a double coincidence of wants.

a) I is true, II is false b) I is false, II is true c) Both I and II are true d) Both I and II are false

SHORT ANSWER SECTION (75 points) Question 1: (20 pts) Consider the following bank’s balance sheet in a banking system with a required reserve ratio of 20% Assets Liabilities Cash: $500 Checking deposits: $10,000 Deposits with the Fed: $1,500 Loans : $8,000

a) What are the legal, required and excess (if any) reserves? (10 pts) b) Starting with the initial balance sheet suppose John walks into his bank and

deposits $300. What is the maximum change in the money supply that the economy can get based solely on his deposit? (Show your work for full credit) (10 pts)

Question 2: (15 points) The oversimplified deposit creation multiplier of 1 divided by the required reserve ratio represents the maximum amount of money supply creation that can be obtained out of a dollar of increase in deposits. The actual increase is smaller due to any of three reasons. List those reasons (5 points each). Question 3: (30 points)

a) Explain what gives value to the money supply in a commodity monetary system (10 points).

b) Explain what gives value to the money supply in a commodity-backed monetary system (10 points).

c) Explain what gives value to the money supply in a fiat monetary system (10 points).

Question 4: (10 points) In country ABC money demand is given by the following equation: Md = 10,000 – 4,000 r + Y Md is money demand, r is the real interest rate and Y is aggregate income. Money supply (Ms) is fixed at Ms = 5,000.

a. Suppose that aggregate income is 3,000. Graph the money demand curve. Why does the equation have a negative slope? (2 points)

b. What is the equilibrium interest rate? (2 points) c. Income rises from Y = 3,000 to Y = 5,000. Ms is still 5,000. At the

previous equilibrium interest rate, there is an excess ------- (supply/demand) of money, By how much? What will happen to the interest rate? (2 points)

d. The new equilibrium interest rate is ------ (2 points) e. How much must the money supply increase to restore the original interest

rate? (2 points)