What Distinguishes Money from Other Assets in the Economy

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Macroeconomics Assignment 4 – Lessons 7& 8
Solutions

1. What distinguishes money from other assets in the economy? (2 Mark)

ANS:

Money is different from other assets in the economy because it is the most liquid asset available. Other assets vary widely in their liquidity.

2. What are demand deposits, and why should they be included in the stock of money? (2 Mark)

ANS:

Demand deposits are balances in bank accounts that depositors can assess on demand simply by writing a cheque or by using a debit card. They should included in the stock of money because they can be used to buy goods and services.

3. If there was no item in the economy widely accepted in return for goods and services, how would transactions be carried out in this economy? How efficient would such a system be? (2 Mark)

ANS:

Without some kind of money to facilitate transactions, society would have to resort to barter — exchanging goods or services for other goods and services. This would be a very inefficient system, because in order for trade to take place, there would need to be a double coincidence of wants, the unlikely occurrence that two people each have a good or service that the other wants. In addition, the two individuals would need to agree on a barter ratio, or price, for the two goods.

4. What is the difference between a medium of exchange and a store of value? (4 Marks)

ANS:

A medium of exchange is an asset that is generally acceptable as payment for goods and services. A store of value is an asset that can be used to transfer purchasing power from the present to the future. Stocks and bonds are stores of value, but because they are not generally acceptable as payment for goods and services, they are not media of exchange.

5. What is the difference between commodity money and fiat money? (2 Mark)

ANS:

Commodity money has "intrinsic value," or value in uses other than as money. Fiat money is established as money by government decree, and has very little, if any, intrinsic value.

6. Are credit cards money? (2 Mark)

ANS:

Credit cards are excluded from all measures of the quantity of money because they are not a method of payment, but a method of deferring payment.

7. Under what circumstance can banks not influence the supply of money? (1 Mark)

ANS:

If banks hold all deposits on reserve (100-percent-reserve banking), banks cannot influence the money supply.

8. What are the two problems facing the Bank of Canada in trying to control the money supply precisely? (2 Marks)

ANS:
The first problem is that the Bank of Canada does not control the amount of money that households wish to hold as deposits in banks. The second problem is that the Bank of Canada does not control the amount that bankers choose to lend.

9. Using separate graphs, demonstrate what happens to money supply, money demand, the value of money and the price level if: (15 Marks)

a. the Bank of Canada increases the money supply.
b. people decide to demand less money at each price level. c. banks decide to hold more excess reserves.

ANS:

In panel A below, the Bank of Canada increases the money supply, shifting the money supply curve from S0 to S1. The equilibrium point moves from E0 to E1, the value of money falls from V0 to V1, and the price level increases from P0 to P1.

In panel B below, people decide to demand less money at each price level. The money demand curve shifts from D0 to D1, the value of money falls from V0 to V1, and the price level increases from P0 to P1.

In panel C below, banks decide to hold more excess reserves. This reduces the money multiplier and the money supply, shifting the money supply curve from S1 to S0, increasing the value of money from V1 to V0, and reducing the price level from P0 to P1

[pic]

10. According to the quantity theory of money, what is...
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