Econ 222

Topics: Money, Bond, Federal Reserve System Pages: 6 (2255 words) Published: February 28, 2013
1. State and explain any two advantage of a monetary economy. State and explain any three functions of money.
In monetary economy is an economy where goods and services are exchanged for money. It can avoid double coincidence of wants, for example, one person is willing to use a bag of rice to get a bag of tea; another person is willing to use a bag of tea to get two apples. These two parties can not trade easily for their goods because in a barter economy people have to find exact goods and services to trade with. People realized use money to purchase goods and services that will save more time to find exact goods and services they want, and convenient for people. The monetary economy also allows specializations, for example, many labors use their own skills to produce more goods and services, one person will be good at making cars wheels, and another people will be good at making cars frames. Once, they gather those products together, they will produce parts more efficient by division of different labors. Last, in monetary economy can economize on price information. Money as a medium of exchange can avoid barter economy; people gather all goods and services together to help others to purchase their needs. Money also has unit of account, it to quote prices on each good and a service; for example, there have one dollar bill, five dollars bill, twenty dollars bill, and a hundred dollar bill to distinguish our needs by different prices. Also, a cow costs $20, it is expensive than a chicken that costs $10. As long as money keep its value stable, people saving money into purchasing power in the future, because money can store of values. 2. State and explain Friedman's Theory of Inflation.

State and explain Fisherian Theory of Interest Rate.
Friedman’s theory of inflation is that there is a lot of money chasing too few goods. For example, diamonds are dropping their prices to every household, because every one can afford the price to buy more diamonds, so that the demand will increase; the supply will decrease and there will not be enough goods and services for every one. Increasing in demand force increase in price, it will cause inflation. Fisherian theory of interest rate is defined by: (1 + nominal interest rate) = (1 + real interest rate) (1 + expected inflation rate); so that (1 + nominal interest rate) = 1 + [(real interest rate) (expected inflation rate)] + real interest rate + expected inflation rate. For example, the real interest rate is the lender receive as income, when the nominal interest rate is 2%, the inflation is also 2%, because the real interest rate is zero; to use the information input the Fisherian theory’s formula, (1 + nominal interest rate) = real interest rate + inflation rate, 2% = real interest rate + 2%, recall the real interest rate is zero. Since an increase money supply growth rate results in inflation, the nominal interest rate should be positively correlated and also will increase more money print it out. An increase in the money supply will cause income to rise, spurring an increase in money demand and interest rates, and an increase in the money supply will stimulate spending, which will then cause prices to rise. Higher prices will increase money demand and raise interest rates.

3. Define an indifference curve. Define an investment opportunity frontier. Define a consumption opportunity curve. Make use of the above and with a diagram to explain the importance of financial intermediation. An indifference curve is the combinations of consumption today and tomorrow that give a consumer the same level of satisfaction. Investment opportunity frontier is the income today and tomorrow that can be achieved when one invests efficiently (see the figure I).

The consumption opportunity curve is the combinations of consumption today and tomorrow that a consumer can afford when one’s uses up all one’s maximum present value income. In the...
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