ECON 2010 Study Guide - Barter, Commodity Money, Open Market Operation

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24 Jun 2014

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By making exchange easier, money allows for specialization and higher productivity. Money serves as a medium of exchange when sellers are willing to accept it in exchange for goods or services. Money serves as a unit of account when each good has a price in terms of dollars. Money serves as a store of value when value is stored, such as in stock, bonds, real estate, and valuable items. Money serves as a standard of deferred payment in borrowing and lending. What can serve as money: there are five criteria that make a good suitable to use as a medium of exchange, the good must be acceptable to (that is, usable by) most traders. The good should be of standardized quality so that any two units are identical. The good should be durable so that value is not lost by spoilage.

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CLASS NOTES ARE LOCATED WHERE IT SAYS CLASS NOTES!

During the early 1700s, a sailing ship is wrecked on an uninhabited island in the Caribbean Sea. The passengers and crew survive but lose all their possessions. There is no source of fresh water on the island, but coconut palm trees are fairly abundant, and the survivors are able to drink milk harvested from coconuts. There are no mammals living on the island, but many birds roost there, and these become a source of meat. There are a number of mango trees that provide fruit. A long, tough form of sawgrass grows in a number of different places on the island. This grass can be woven into knee-length sleeveless shirts, which are the basic type of clothing for people of both genders. The people on this island have developed a simple system of direct market exchange. Currently, two mangos trade for five coconuts, six coconuts trade for a pound of meat, and three pounds of meat trade for four shirts.

1. Use a formula that was stated in class, and in my notes, to calculate the total number of distinct relative prices in the islandâs economy. Note that when this formula is used to count relative prices, any given pair of goods is considered to have only one relative price. For example, if we count the price of a pound of meat in mangos as one relative price, then we donât count the price of mangos in pounds of meat as a second relative price.

(Class Notes: In a barter economy with markets, each good should have a market price, per unit, in terms of each of the other goods: baskets of fish per bushel of apples, bags of coconuts per bushel of apples, etc. A price of this type â units of one good per unit of the other good â is called a relative price (alternatively, a barter price). If there are different goods traded in an economy, then there turn out to be relative prices for a merchant to keep track of, in each market he visits. Each of the n goods has unit prices: one for each of the other goods. We divide by two to avoid counting reciprocal duplicates: if it costs 2 bags of coconuts to buy a bushel of apples, then it costs 1/2 bushel of apples to buy a bag of coconuts, and so on. )

2. Use the price information you are given to calculate all the distinct relative prices. Remember that the prices we are interested in are unit prices. A unit price is the price of a single unit of one good in units of another good. For each pair of goods, use the order that produces the highest unit price. In the case of coconuts and shirts, for example, if the price of a shirt in coconuts is higher than the price of a coconut in shirts, then report the first price but not the second one. Note: In calculating unit prices, donât worry about issues of divisibility. Assume that any good can be divided in any way, so that fractions or decimals can be components of unit prices.

3. For each relative price you just calculated, calculate the relative price if the order of the two items is switched. (In the scenario above, for example, you would now calculate the price of a coconut in shirts.) What very simple formula can you use to do this? Explain briefly.

4. Now suppose the people on this island start using mangos as money. The relative prices on the island do not change, and the absolute prices are consistent with them. a. Use a formula stated in class, and in my notes, to calculate the total number of absolute prices in the islandâs economy. b. Report these absolute prices.

Class Notes: ( In a monetary economy, in contrast, each good has a single absolute price (alternatively, a money price), which is its unit price in terms of money: dollars per bushel of apples, etc. If we assume that one of the n goods is used as money, then a merchant only needs to keep track of absolute prices. As long as there are more than two different goods ( ), it turns out that , and the difference between these two numbers gets very big as n gets large. Even if there are only 10 different goods, then there are 45 relative prices and only 9 absolute prices. And if there are 100 different goods, which is a more realistic number, then there are 99 absolute prices but almost 5000 relative prices.)

5. Comment briefly on the potential advantages and disadvantages of using mangos as money, using our list of the desirable properties of money as a guide.

6. Suppose you are a merchant on this island, where mangos are used as money in the market (see Item 4 above). A competing merchant who dislikes using money in transactions is willing to trade coconuts for shirts (or vice-versa) directly, at a rate of five coconuts per shirt. Explain, carefully and completely, how you could use this merchantâs willingness to trade these two goods, at this rate, in order to make a profit of one unit of money for yourself by (1) using money to buy units of a good in the market, (2) trading those units of the good to this merchant, in exchange for units of another good, and (3) selling those units in the market for money. Identify the items traded and the quantities, and verify the amount of the profit. Finally, explain what you would need to do in order to make a larger profit (double, for example).

Question 1. Which of the following is not included in M1?
a- currency
b- demand deposits
c- traveller's checks
d- credit cards

Question 2. When the Fed purchases $200 worth of government bonds from the public, the U.S. money supply eventually increases by

a- more than $200.
b- exactly $200.
c- less than $200.
d- None of the above are correct.

Question 3. Savings deposits are included in

a- M1 but not M2.
b- M2 but not M1.
c- M1 and M2.
d- neither M1 nor M2.

Question 4. Credit cards

a- defer payments.
b- are a store of value.
c- have led to wider use of currency.
d- are part of the money supply.

Question 5. Table 16-3.
The First Bank of Fairfield

Assets	Liabilities
Reserves $2,000	Deposits $10,000
Loans 8,000

Refer to Table 16-3. The reserve ratio for this bank is

a- 0 per cent.
b- 20 percent.
c- 80 per cent.
d- 100 per cent.

Question 6. If an economy uses silver as money, then that economy's money

a- serves as a store of value but not as a medium of exchange.
b- serves as a medium of exchange but not as a unit of account.
c- is commodity money.
d- has no intrinsic value.

Question 7. In the United States, currency holdings per person average about

a- $125; one explanation for this relatively small average is that many people use credit and debit cards to make transactions.
b- $125; one explanation for this relatively small average is that U.S. citizens hold a lot of foreign currency.
c- $3,700; one explanation for this relatively large amount is that criminals probably prefer currency as a medium of exchange.
d- $3,700; one explanation for this relatively large average is that U.S. citizens hold a lot of foreign currency.

Question. 8. Money is the most liquid asset available because

a- it is a store of value.
b- it is a medium of exchange.
c- it is a unit of account.
d- it has intrinsic value.

Question 9. All Fed purchases and sales of

a- corporate stocks and bonds are conducted at the New York Fed's trading desk.
b- government bonds are conducted at the New York Fed's trading desk.
c- real estate and other real assets are conducted by the Federal Open Market Committee.
d- All of the above are correct.

Question 10. The Fed's policy decisions have an important influence on

a- inflation in the long run and employment and production in the short run.
b- inflation in the long run and employment and production in the long run.
c- inflation in the short run and employment and production in the short run.
d- inflation in the short run and employment and production in the long run.

emeraldhamster861

1. Which of the following both increase the money supply?

an increase in the discount rate and an increase in the interest rate on reserves
an increase in the discount rate and a decrease in the interest rate on reserves
a decrease in the discount rate and an increase in the interest rate on reserves
a decrease in the discount rate and a decrease in the interest rate on reserves

2. In the U.S., the average adult holds about $3,700 in

currency.
wealth.
M1.
M2.

3. The measure of the money stock called M1 includes

wealth held by people in their checking accounts.
wealth held by people in their savings accounts.
wealth held by people in money market mutual funds.
everything that is included in M2 plus some additional items

4. When the Fed decreases the discount rate, banks will

5. Reserve requirements are regulations concerning

the amount banks are allowed to borrow from the Fed.
the amount of reserves banks must hold against deposits.
reserves banks must hold based on the number and type of loans they make.
the interest rate at which banks can borrow from the Fed.

6. When we say that trade is roundabout we mean that

people sometimes trade goods for goods.
trades require a double coincidence of wants.
currency is accepted primarily to make further trades.
people must spend time searching for the products they wish to purchase.

7. Values of Assets

Asset	Amount in $Billions
Small-time deposits	780
Large time deposits	1,700
Demand deposits	450
Other checkable deposits	370
Savings deposits	4950
Traveller's checks	5
Money market mutual funds	740
Currency	880
Miscellaneous categories of M2	50

Refer to Value of Assets. What is the value of M1 in billions of dollars?

1705
2485
6295
7075

8. In 1991, the Federal Reserve lowered the reserve requirement from 12 per cent to 10 per cent. Other things the same this should have

increased both the money multiplier and the money supply.
decreased both the money multiplier and the money supply.
increased the money multiplier and decreased the money supply.
decreased the money multiplier and increased the money supply.

9. Consider four survivors on an island.

Rupert	has machete	wants fishing spear
Amber	has cooking pot	wants fishing spear
Rob	has fishing spear	wants machete
Tom	has cooking pot	wants machete

Which of the following pairs of survivors has a double-coincidence of wants?

Rupert with Amber, and Rob with Tom
Amber with Tom
Rupert with Rob
None of the above is correct.

10. Economists use the term money to refer to

all wealth.
all assets, including real assets and financial assets.
all financial assets, but not real assets.
those types of wealth that are regularly accepted by sellers in exchange for goods and services.

crimsongrasshopper834

ECON 2010 Study Guide - Barter, Commodity Money, Open Market Operation

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