**Please answer ALL of the following questions** 1) What are the three functions
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Question
**Please answer ALL of the following questions**
1) What are the three functions of money? Which function is the defining characteristic?
2) How is the discount rate different from the federal funds rate?
3) Consider the balance sheet for the Wahoo bank as presented below.
Wahoo Bank Balance Sheet
Assets
Liabilities
government securities
$1,600
Liabilities: Checking accounts
$4,000
Required Reserves
$400
Net Worth
$1,000
Excess Reserves
$0
Loans
$3,000
Total Assets
$5,000
Total Liabilities
$5,000
Using a required reserve ratio of 10% and assuming that the bank keeps no excess reserves, write the changes to the balance sheet for each of the following scenarios:
Bennett withdraws $200 from his checking account.
Roland deposits $500 into his checking account.
The Fed buys $1,000 in government securities from the bank.
The Fed sells $1,500 in government securities to the bank.
4) Using a required reserve ratio of 10% and assuming that banks keep no excess reserves, which of the following scenarios produces a larger increase in the money supply, explain why.
a) Someone takes $1000 from under his or her mattress and deposits it into a checking account.
b) The Fed purchases $1,000 in government securities from a commercial bank.
5) Using a required reserve ratio of 10% and assuming that banks keep no excess reserves, what is the value of government securities the Fed must purchase if it wants to increase the money supply by $2 million?
Wahoo Bank Balance Sheet
Assets
Liabilities
government securities
$1,600
Liabilities: Checking accounts
$4,000
Required Reserves
$400
Net Worth
$1,000
Excess Reserves
$0
Loans
$3,000
Total Assets
$5,000
Total Liabilities
$5,000
Explanation / Answer
Q1.
The three functions of money are –
1. Money serves as medium of exchange.
2. Money serves as store of value.
3. Money serves as measure of value.
Money serves as medium of exchange –
The most important function of money is that it serves as medium of exchange. In barter economy, exchange of goods and services require double coincidence of wants. However, with use of money, goods and services can be exchanged without any need of double coincidence of want to happen. As money is generally accepted, a person can sell his goods or services for money and can later use that same amount to purchase goods or services that he wants.
Money serves as store of value –
Money acts as store of value. This store of value function implies that money can be used to store wealth. In other words, money can be held as an asset. Anything that has to be chosen as money should be such that it can easily be stored without any deterioration in its value then only it can perform the store of value function in effective manner. Gold, bonds, factories etc. can also serves as store of value but money being most liquid asset can be utilized for making payment anywhere anytime. This is not the case with these other alternatives.
Money serves as measure of value –
Money serves as measure of value in the sense that it can be used as yardstick for measuring the value of goods and services. This helps in putting the value of all goods and services in a common denominator and thus their relative values can easily be compared.
Money serves as medium of exchange. This function is the defining characteristic of money because money is generally defined as something that is generally acceptable as a medium of exchange that is it is generally accepted as payment for goods and services.
Q5.
Required reserves ratio = 10% or 0.10
Total increase in money supply = $2 million
Calculate Money Multiplier –
Money multiplier = 1/Required reserve ratio = 1/0.10 = 10
The value of money multiplier is 10.
When Fed purchase the government securities from open market , total money supply increases by an amount equal to value of government securities purchased times the money multiplier.
In equation form,
Total increase in money supply = Amount of government securities purchased by Fed * Money multiplier
$2 million = Amount of government securities purchased by Fed * 10
Amount of government securities purchased by Fed = $2million/10
Amount of government securities purchased by Fed = $0.2 million
Thus, Fed will purchase securities worth $0.20 million, if it wants to increase the money supply by $2 million.
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