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1. Why is simply counting currency an inadequate measureof money?2. In prison, cigarettes are sometimes used among inmatesas a form of payment. How is it possible for cigarettesto solve the “double coincidence of wants” problem,even if a prisoner does not smoke?3. Three goods are produced in an economy by threeindividuals:Good ProducerApples Orchard ownerBananas Banana growerChocolate ChocolatierIf the orchard owner likes only bananas, thebanana grower likes only chocolate, and the chocolatierlikes only apples, will any trade between thesethree persons take place in a barter economy? Howwill introducing money into the economy benefit thesethree producers?4. Why did cavemen not need money?5. Most of the time it is quite difficult to separate thethree functions of money. Money performs its threefunctions at all times, but sometimes we can stress onein particular. For each of the following situations, identifywhich function of money is emphasized.a. Brooke accepts money in exchange for performingher daily tasks at her office, since she knows she canuse that money to buy goods and services.b. Tim wants to calculate the relative value of orangesand apples, and therefore checks the price per poundof each of these goods as quoted in currency units.c. Maria is currently pregnant. She expects her expendituresto increase in the future and decides toincrease the balance in her savings account.6. In Brazil, a country that underwent a rapid inflationbefore 1994, many transactions were conducted in dollarsrather than in reals, the domestic currency. Why?7. Was money a better store of value in the United Statesin the 1950s than in the 1970s? Why or why not? Inwhich period would you have been more willing tohold money?8. Why have some economists described money during ahyperinflation as a “hot potato” that is quickly passedfrom one person to another?9. Why were people in the United States in the nineteenthcentury sometimes willing to be paid by check ratherthan with gold, even though they knew there was apossibility that the check might bounce?10. In ancient Greece, why was gold a more likely candidatefor use as money than wine?11. If you use an online payment system such as PayPal topurchase goods or services on the Internet, does thisaffect the M1 money supply, the M2 money supply,both, or neither? Explain.12. Rank the following assets from most liquid to least liquid:a. Checking account depositsb. Housesc. Currencyd. Automobilese. Savings depositsf. Common stock13. Which of the Federal Reserve’s measures of the monetaryaggregates—M1 or M2—is composed of the mostliquid assets? Which is the larger measure?14. It is not unusual to find a business that displays a signsaying “no personal checks, please.” On the basis ofthis observation, comment on the relative degree ofliquidity of a checking account versus currency.15. For each of the following assets, indicate which of themonetary aggregates (M1 and M2) includes them:a. Currencyb. Money market mutual fundsc. Smalldenomination time depositsd. Checkable deposits16. Assume that you are interested in earning some returnon the idle balances you usually keep in your checkingaccount and decide to buy some money market mutualfunds shares by writing a check. Comment on theeffect of your action (with everything else the same) onM1 and M2.17. In April 2009, the growth rate of M1 fell to 6.1%, whilethe growth rate of M2 rose to 10.3%. In September 2013,the yearoveryear growth rate of the M1 money supplywas 6.5%, while the growth rate of the M2 moneysupply was about 8.3%. How should Federal Reservepolicymakers interpret these changes in the growthrates of M1 and M2?18. Suppose a researcher discovers that a measure of thetotal amount of debt in the U.S. economy over the pasttwenty years was a better predictor of inflation andthe business cycle than M1 or M2. Does this discoverymean that we should define money as equal to the totalamount of debt in the economy?
1 Why is simply counting currency an inadequate measure of money? Because there are other liquid assets (cash in Hand, Marketable Securities…) which are similar to currency that can be used as money to purchase goods and services In prison, cigarettes are sometimes used among inmates as a form of payment How is it possible for cigarettes to solve the “double coincidence of wants” problem, even if a prisoner does not smoke? Because even if he or she were a non-smoker, since the prisoner knows that others in the prison will accept cigarettes as a form of payment, they themselves would be willing to accept cigarettes as a form of payment So, rather than prisoners having to barter and trade favors, cigarettes satisfy the double coincidence of wants in that both parties to a trade stand ready to use them to "purchase" goods or services Three goods are produced in an economy by three individuals: Good Producer Apples Orchard owner Bananas Banana grower Chocolate Chocolatier If the orchard owner likes only bananas, the banana grower likes only chocolate, and the chocolatier likes only apples, will any trade between these three persons take place in a barter economy? How will introducing money into the economy benefit these three producers? Because the orchard owner likes only bananas but the banana grower doesn't like apples, the banana grower will not want apples in exchange for his bananas, and they will not trade Similarly, the chocolatier will not be willing to trade with the banana grower because she does not like bananas The orchard owner will not trade with the chocolatier because he doesn't like chocolate Hence, in a barter economy, trade among these three people may well not take place, because in no case is there a double coincidence of wants However, if money is introduced into the economy, the orchard owner can sell his apples to the chocolatier and then use the money to buy bananas from the banana grower Similarly, the banana grower can use the money he receives from the orchard owner to buy chocolate from the chocolatier, and the chocolatier can use the money to buy apples from the orchard owner The result is that the need for a double coincidence of wants is eliminated, and everyone is better off because all three producers are now able to eat what they like best Why did cavemen not need money? In cavemen’s primitive economy, they did not specialize in producing one type of good and they had little need to trade with other cavemen Most of the time it is quite difficult to separate the three functions of money Money performs its three functions at all times, but sometimes we can stress one in particular For each of the following situations, identify which function of money is emphasized a Brooke accepts money in exchange for performing her daily tasks at her office, since she knows she can use that money to buy goods and services b Tim wants to calculate the relative value of oranges and apples, and therefore checks the price per pound of each of these goods as quoted in currency units c Maria is currently pregnant She expects her expenditures to increase in the future and decides to increase the balance in her savings account a) b) c) Medium of exchange Unit of account Store of value In Brazil, a country that underwent a rapid inflation before 1994, many transactions were conducted in dollars rather than in reals, the domestic currency Why? Because of the rapid inflation in Brazil, the domestic currency, the real, was a poor store of value Thus many people preferred to hold dollars, which were a better store of value, and used them in their daily shopping Was money a better store of value in the United State in the 1950s than in the 1970s? Why or why not? In which period would you have been more willing to hold money? Because money was losing value at a slower rate (the inflation rate was lower) in the 1950s than in the 1970s, it was a better store of value then, and you would have been willing to hold more of it Why have some economists described money during a hyperinflation as a “hot potato” that is quickly passed from one person to another? Money loses its value at an extremely rapid rate in hyperinflation, so you want to hold it for as short a time as possible Thus money is like a hot potato that is quickly passed from one person to another Why were people in the United States in the nineteenth century sometimes willing to be paid by check rather than with gold, even though they knew there was a possibility that the check might bounce? Because a check was so much easier to transport than gold, people would frequently rather be paid by check even if there was a possibility that the check might bounce In other words, the lower transactions costs involved in handling checks made people more willing to accept them 10 In ancient Greece, why was gold a more likely candidate for use as money than wine? Because Wine is more difficult to transport than gold and is also more perishable Gold is thus a better store of value than wine and also leads to lower transactions cost It is therefore a better candidate for use as money 11 If you use an online payment system such as PayPal to purchase goods or services on the Internet, does this affect the M1 money supply, the M2 money supply, both, or neither? Explain PayPal is used to make online money transfers and serves as an alternative to paying with traditional paper money, such as currency, checks, etc Online payments would not affect neither M1 or M2 because the aggregate amount of money in M1 or M2 does not change 12 Rank the following assets from most liquid to least liquid: a Checking account deposits b Houses c Currency d Automobiles e Savings deposits f Common stock 1.Currency 2.Checking account 3.deposits 4.Savings deposits 5.Common Stock 6.Automobiles 7.Houses 13 Which of the Federal Reserve’s measures of the monetary aggregates— M1 or M2—is composed of the most liquid assets? Which is the larger measure? • • M1 is most liquid M2 is the largest measure because it includes all of M1 + smalldenomination time deposits + saving deposits and money market deposit accounts + money market mutual fund shares 14 It is not unusual to find a business that displays a sign saying “no personal checks, please.” On the basis of this observation, comment on the relative degree of liquidity of a checking account versus currency Based on this observation, a checking account must be less liquid than currency 15 For each of the following assets, monetary aggregates (M1 and M2) includes them: a Currency b Money market mutual funds indicate which of the c Small-denomination time deposits d Checkable deposits • M1 includes currencies, checkable deposits • M2 includes M1 and, in addition, short-term time deposits in banks and certain money market funds 16.Assume that you are interested in earning some return on the idle balances you usually keep in your checking account and decide to buy some money market mutual funds shares by writing a check Comment on the effect of your action (with everything else the same) on M1 and M2 Your actions will reduce your checking account balance and increase your holdings of money market mutual fund shares Considering this transaction only, M1 will decrease as one of its components decreased M2 will remain constant, as M2 is composed of all items that add up to M1 plus some other types of money that are not so liquid to be considered part of M1 One of these categories is money market mutual fund shares The decrease in your checking account balance is offset by the increase in money market mutual fund shares, and therefore M2 remains constant 17 In April 2009, the growth rate of M1 fell to 6.1%, while the growth rate of M2 rose to 10.3% In September 2013, the year-over-year growth rate of the M1 money supply was 6.5%, while the growth rate of the M2 money supply was about 8.3% How should Federal Reserve policymakers interpret these changes in the growth rates of M1 and M2? During the period in question, the M1 growth rate increased by 17 percentage points, while the M2 growth rate increased by only percentage points Although both measures are moving in the same direction, the magnitude of the difference in growth rates between the two makes it difficult to judge the appropriateness of monetary policy by just looking at the money supply measures alone For instance, if one focused just on the M2 money supply, knowing the economy was in severe economic contraction would suggest that the growth rate of M2 perhaps should be even higher than the percentage point increase over this time On the other hand, if one just focused on the M1 growth increase of 17 percentage points, this may seem alarmingly high and suggest an inflationary problem in the future 18 Suppose a researcher discovers that a measure of the total amount of debt in the U.S economy over the past twenty years was a better predictor of inflation and the business cycle than M1 or M2 Does this discovery mean that we should define money as equal to the total amount of debt in the economy? Not necessarily Although the total amount of debt has predicted inflation and the business cycle better than M1 or M2, it may not be a better predictor in the future Without some theoretical reason for believing that the total amount of debt will continue to predict well in the future, we may not want to define money as the total amount of debt