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Satisfactory Essays
Econ 304 Spring 2013
Problem Set #2 Due by 11:59 PM MST February 15
Please ensure you show all work on your answers.

1. (5 points each part)
To increase tax revenue, the U.S. government imposed a 2-cent tax on checks written on bank account deposits.
a.
How do you think the check tax affected the currency-deposit ratio?

b.
Use the model of the money supply under fractional reserve banking to discuss how this tax affected the money supply.

c.
Many economists believe that a falling money supply was in part responsible for the severity of the Great Depression of the 1930's. From this perspective, was the check tax a good policy to implement in the middle of the Great Depression? Why or why not.

2. (6 points each part)
An economy has a monetary base 1,000 $1 bills. Calculate the money supply in scenarios (a)-(d) and then answer part e.
a.
All money is held as currency
b.
All money is held as demand deposits. Banks hold 100% of deposits as reserves

c.
All money is held as demand deposits. Banks hold 20% of deposits as reserves
d.
People hold equal amounts of currency and demand deposits. Banks hold 20% of deposits as reserves.
e.
The central bank decides to increase the money supply by 10%. In each of the above four scenarios, how much should it increase the monetary base?

3. (5 points each part)
A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year."
a.
Why does inflation affect the increase in Social Security and other benefits?

b.
Is this effect a cost of inflation, as the article suggests? Why or why not.

4. (5 points each part)
Suppose a country has a money demand function (M/P)d=kY, where k is a constant parameter. The money supply grows by 12% per year, and real income grows by 4%.
a.
What is the average inflation rate?

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