1 of 2 ~i-Exam #3 Study Guide Chapter 13- approximately 12 questions Understand
ID: 1124548 • Letter: 1
Question
1 of 2 ~i-Exam #3 Study Guide Chapter 13- approximately 12 questions Understand how to construct and use the AD curve/Understand how to construct and use the LRAS curve / Know what shifts the AD curve /Understand real shocks Explain business fluctuations and the business cycle / Explain temporary changes in the growth rate of velocity/Describe how the AD/AS model returns to long-run equilibrium in different scenarios / Know these terms: business fluctuations, recession, aggregate demand curve, Solow growth rate, long-run aggregate supply curve, real shock, aggregate demand curve, short-run aggregate supply curve Chapter 14 approximately 5 questions Understand how the transmission and amplification mechanisms can cause a shock to the economy to grow and spread Know these terms: intertemporal substitution, irreversible investments, labor adjustment costs, time bunching, collateral shock Chapter 15 approximately 10 questions Describe the Federal Reserve System /Understand the functions of money Know the different definitions of the money supply Explain how banks create money through lending /Describe opern market operations/ Describe discount rate lending directly to banks/Understand systemic risk and moral hazard/ Show how monetary policy works in the AD/AS model / Know these terms: money, fractional reserve banking, reserve ratio (RR), money multiplier (MM), open market operations, Federal funds rate, lender of last resort, discount rate, insolvent bank, illiquid bank, systemic risk, moral hazard Describe the best case scenario for monetary policy Explain why monetary policy is difficult in real life / Describe the dangers of fighting inflation Explain why negative real shocks create a dilemma for policymakers / Understand the rules vs. discretion debate Know these terms: disinflation, deflation Chapter 17 - approximately 10 questions Understand the sources of government tax revenue Understand the components of government spending /Demonstrate how individual income taxes are calculated /Describe the distribution of the tax burden in the US / Describe the national debt held by the publicExplain the problems with the national debt held by the public/Know these terms: marginal tax rate, average tax rate, progressive tax, flat tax, regressive tax, national debt held by the public, deficit Chapter 18-approximately 6 questions Describe the best case scenario for fiscal policy/Explain the limits to fiscal policy / Describe the conditions under which fiscal policy is a good idea/ Know these terms: fiscal policy, multiplier effect, crowding out, Ricardian equivalence, automatic stabilizersExplanation / Answer
15.
Money is anything which is generally acceptable as a medium of exchange. Functions of money includes:
a) Medium of Exchange: It means that money acts as a medium for the sale and purchase of goods and services. In the absence of money, goods were exchanged for goods. This required double coincidence of wants. Accordingly, an exchange was difficult, and therefore limited. The introduction of money has separated the acts of sale and purchase: a double coincidence of wants is no longer required. The exchange is now much simpler and is, therefore, unlimited. This has raised the overall level of economic activity in an economy.
b) Measure of Value or Unit of Value: Money serves as a measure of value in terms of unit of account. Unit of account means that the value of each good or service is measured in the monetary unit. Measurement of value was very difficult in the barter system: one good was valued in terms of the other. There was no common unit of value. An introduction of money has removed this difficulty. Now, each good is valued in terms of money.
c) Standard of deferred payments: Deferred payments refer to those payments which are made sometimes in the future. When we borrow money from somebody, we have to return both the principal as well as interest amount. It is difficult to make such transactions in terms of goods and services. Money performs this function most effectively.
d) Transfer of Value: Money also serves as a convenient mode of transfer of value. Goods are purchased from far-off places both for consumption as well as investment.
Open market operation: Open market operation is the sale and purchase of government securities in the open market by the central bank. By selling the securities, the central bank withdraws cash balances from the economy. And, by buying the securities, the central bank adds to cash balances in the economy. During inflation, central bank sell government securities and reduce the money supply and on the other hand, during deflation, central bank buy government securities.
Lender of the Last Resort: It means that if a commercial bank fails to get financial accommodation from anywhere, it approaches the Federal Reserve as a last resort. Central or Federal bank advances loan to such a bank against approved securities. By offering loans to the commercial banks in situation of emergency, the Federal reserve ensures i) that the banking system of the country does not suffer any set-back and ii) that money market remains stable.
Moral hazards: This implies taking the advantage of asymmetric information after transaction. For example, if someone has car insurance he may commit theft by getting his car stolen to reap the benefits of the insurance.
Money creation by Banks:
Commercial banks are the creators of money supply in the economy. They contribute to the money supply by creating credit. They create credit in the form of demand deposits. Demand deposits of the commercial banks are many times more than cash reserves. If cash reserves are $ 1000 and if demand deposits say $ 10,000, then commercial banks are creating credit ten times of their cash reserves. Accordingly, on the basis of cash reserves of $ 1000, the commercial banks are contributing $ 10,000 to the supply of money. The steps involved in the creation of money are as follows:
1) Commercial banks know by their historical experience that, all the depositors would not show up in the banks to withdraw all their deposits at a point of time.
2) Commercial banks will maintain a reserve of 10% if they experience withdrawals are generally around 10% of total deposits. This is known as CRR i.e. Cash Reserve ratio.
3) If CRR = 10%, total cash reserves will be $ 1000 which allow the bank to loan up to $ 10,000 in accordance with the given formula:
Demand deposits = 1/CRR X Cash reserves = 1/10% X 1000 = $ 10,000
It is important to note that Loans are never offered in cash. These are always reflected as demand deposits in favor of the borrowers.
4) Now we can say that if cash reserves of the bank increased by 1000 then credit supply increases by $ 10,000 on the assumption that CRR = 10%.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.