ECO 203 Problem Set 7

ECO 203 PROBLEM SET 7

     Figure 14-1

1.   In Figure 14-1, which graph represents the outcome of an open market sale of government securities by the Fed?

2.   In Figure 14-1, which graph represents the outcome of an increase in the price level?

3.   In Figure 14-1, which graph represents the outcome of a decrease in the real GDP?

4.   In Figure 14-1, which graph represents the outcome of an increase in reserve requirements?

5. A bank finds itself short of required reserves and therefore borrows from another commercial bank. The interest rate on this loan is

a. zero

b. the prime rate

c. the discount rate

d. the federal funds rate

e. the required reserve ratio

6. An expansionary monetary policy is most likely to produce a higher price level with little impact on output when:

a. the economy is near full employment and the aggregate supply curve is vertical

b. the economy is near full employment and the aggregate supply curve is horizontal

c. the economy has substantial unemployment and the aggregate supply curve is vertical

d. the economy has substantial unemployment and the aggregate supply curve is horizontal

7. Narrowly defined, the money supply consists primarily of

a. coins

b. currency

c. cash held by banks

d. checkable deposits

     e.         money market mutual fund accounts

8. Suppose the required reserve ratio is 0.10 and Linda deposits $4,000 in cash at the College State Bank. If the bank held no excess reserves before Linda’s deposit and now increases its reserves by $500, which of the following is true?

a. The bank must have lent out an additional $4,000.

b. The $500 are required reserves.

c. The bank has excess reserves of $100.

d. Both the bank’s assets and its liabilities rise by $500.

e. The bank has $500 in excess reserves.

9. Suppose a commercial bank’s reserves increase by $3,000 and the bank, which holds no excess reserves, makes a loan of $2,400. What is the required reserve ratio?

a. 0.10

b. 0.20

c. 0.25

d. 0.75

e. 4

10. The liquidity of an asset

a. describes the ease of conversion to cash without significant loss of value

b. is its cash value relative to other assets

c. indicates how much interest would flow from it if it were a financial instrument

d. is of little concern to bank managers, since their primary goal is profit

e. usually rises along with an asset’s rate of return

11. Liquidity contributes to the bank’s achievement of all of the following except

a. confidence of the depositors

b. income of the bank

c. ability to pay funds out to depositors on demand

d. flexibility in responding to investment opportunities

e. ability to make an immediate loan to a valued customer

12. The immediate effect of a member bank’s sale of U.S. government securities to the Fed is a(n)

a. increase in that bank’s required reserves

b. decrease in that bank’s required reserves

c. increase in that bank’s excess reserves

d. decrease in that bank’s excess reserves

e. decrease in the Fed’s assets

13. Tony deposits $2,000 in cash at the Last National Bank and the bank credits Tony’s
checking account in the amount of $2,000. Which of the following is true immediately
after this transaction?

a. The money supply, M1, increases by $2,000.

b. Only the composition of M1 changes, not its amount.

c. A $2,000 loan from the Last National Bank is an asset to Tony.

d. Both the assets and the liabilities of the Last National Bank fall by $2,000.

e. The immediate effect of this transaction is that M1 increases by $2,000 times the money multiplier.

14. If each bank in the United States had to keep 100 percent of checkable deposits as reserves, each $1 the Fed injected into new reserves could increase the money supply by as much as

a. $1

b. $2

c. $100

d. zero

     e. a penny

15. What is the essential factor that enables commercial banks to create money?

a. required reserves

b. excess reserves

c. state and local government securities

d. U.S. government securities

e. net worth

15. Which of the following would likely increase the money supply?

a. One bank buys government securities from another bank.

b. The required reserve ratio increases.

c. The Fed increases the reserves of commercial banks and the banks hold these as
excess reserves.

d. The discount rate increases.

e. A bank sells government securities to the Fed.

16. In the money and credit expansion process, when r = the required reserve ratio, the total change in checkable deposits is equal to the initial change in excess reserves

a. multiplied by r

b. plus the change in required reserves

c. divided by 1/r

d. multiplied by 1/r

e. divided by the change in required reserves

17. The banking system creates money in the sense that it

a. prints money

b. creates excess reserves from loans

c. creates loans from excess reserves

d. creates required reserves from loans

e. creates loans from required reserves

18. Suppose the required reserve ratio is 0.2 and the Fed buys $100,000 in government securities from Big Bank. How much money can the commercial banking system create?

a. $1,000,000

b. $500,000

c. $100,000

d. $80,000

e. none

19. If banks allow some of their excess reserves to remain in the vault,

a. the simple money multiplier will exceed the actual money multiplier

b. the simple money multiplier will understate the expansion of credit

c. the actual money multiplier and the simple money multiplier will be equal

d. banks will earn more interest

e. credit expansion will be greater than if they had lent out these reserves

20. When people choose to hold some of a newly received loan as cash instead of keeping it in a checking account, the money supply

a. will not increase as a result of that loan

b. decreases as a result of that loan

c. will not increase as much from that point on as it would if borrowers redeposited all of the money because the cash withdrawal increases excess reserves

d. will not increase as much from that point on as it would if borrowers redeposited all of the money because cash is not included in the money supply

e. will not increase as much from that point on as it would if borrowers redeposited all of the money because the cash withdrawal decreases excess reserves

21.  The objective of the Fed's expansionary monetary policy may be more difficult to achieve if:

     a.   interest rates are already very low

     b.   interest rates are already very high

     c.   investment spending is very responsive to fluctuations in the interest rate

     d.   the money demand curve is very steep

22.   Suppose, in 2002, "M1" was $396 billion, currency in circulation was $112 billion and required reserves were $44 billion.  Real "GDP" in 2002 was $1,482 billion and nominal "GDP" was $2,629 billion. What is the velocity of money in 2002?

23. Explain what a 60 billion dollar increase in M (money supply) would do to GDP under the following assumptions:

a. each $10B increase in M, lowers r by 1%

b. each 1% drop in r, stimulates I by 20 billion

                c. spending multiplier is 2

24.  Consider the following model of a simple economy in which investment is related to interest rates

                         Y = C + I + G

                         C = 100 + 0.8Y

                         I = 370 - 100r

                         G = 100

     Find the equilibrium GDP if the "fed" sets the rate of interest at r = 10%.

ECO 203 PROBLEM SET 7

Money

Money

Money

Money