Supply and Demand

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MGMT E-2000
Fall, 2012

Problem Set 1
(Due Tuesday, Sept. 25)
(100 pts.)

1.(10 pts.)

Explain the distinction between direct and indirect finance.

2.(10 pts.)

Discuss the reasons for the decline we have witnessed over the past 30 years in the number of U.S. banks.

3.(30 pts.)

Suppose the total amount of reserves in the economy is $5 billion, and the public does not directly hold any cash. Also, suppose all banks hold excess reserves equal to 4% of deposits and the required reserve ratio is 5%.

a.(5 pts.)

Calculate the money multiplier.

b.(5 pts.)

What is the total money supply (or money stock)?

c.(10 pts.)

Bank of America (BOA) has $300 million in deposits and $10 million in net worth. Draw a balance sheet for BOA.

Now suppose that all banks in the economy decide to reduce excess reserves to just 1%.

d.(5 pts.)

Explain in general why banks might want to keep some excess reserves. Also explain why banks want to keep excess reserves as low as possible.

e.(5 pts.)

Calculate the new equilibrium money stock.

4.(25 pts.)

Assume the public in Sylvania holds $4 billion in cash. All commercial banks are required to hold 20% of their checking deposits as reserves. All banks in Sylvania are identical, and have the following identical balance sheets:

|ASSETS |LIABILITIES & BANK CAPITAL | | Reserves $ 50M | Checking Deposits ? | | Loans $ 300M | BANK CAPITAL $ 150M |

Assume that this balance sheet is complete, i.e., lists all assets and capital of these banks, and that the only liability of the banks is checking deposits.

a.(5 pts.)

Find the dollar amount of checking deposits...
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