Econ-112                                 Worksheet #6                          


1.      List the three basic functions of money and briefly explain how each function

allows the economy to operate more efficiently than if barter was the primary means of making transactions.


2.     a.)  Describe three different types of money.

   b.)  Define and explain Gresham’s Law


3.   a.)  Explain what is meant when we say that the banking system in the U.S. is a  fractional reserve banking system.

b.)  What two items comprise the reserves of a bank?

c.)  What items make up the monetary base?

d.)    How is the monetary base related to the money supply?


4.  Use an appropriate balance sheet for this problem.  Rock Solid Savings and Loan has total assets comprised of reserves, loans, and other assets; and total liabilities comprised of deposits and borrowing and other liabilities.  (remember: total assets = total liabilities + net worth)


Given the following information:  the S&L has I.)  $1,800,000 in loans, ii.)  $90,000 in other assets, iii.)  $10,000 (total) in borrowing and other liabilities, iv.)  $2 million in deposits and v.)  the reserve requirement is 10% and the S&L has no excess reserves.

a.)    How much does Rock Solid Savings and Loan have in reserves? 

b.)   What is the net worth of Rock Solid Savings and Loan? 

c.)    Suppose that Rock Solid finds out that $75,000 of its loans are “bad loans” and have to be written off.  Would Rock Solid still be solvent if this happened?  Explain.


5.  For this problem assume that I.)  the public holds all money in the form of demand deposits, ii.)  banks hold no excess reserves, iii.)  the reserve requirement is 5%, iv.)  the discount rate is 10%, and v.)  the money supply, M1, is currently $1350 billion.


a.)  What is the value of the money multiplier for this example?

b.)  If the Fed sells $50 million worth of government securities on the secondary bond market would the monetary base change?  If so, by how much?

c.)  Does the money supply change?  If so by how much?

d.)  What is the new level of the money supply?

6.     Federal Reserve questions.

a.)    Explain two things that are out of the Fed's control that would decrease the size of the actual money multiplier for the economy.

b.)   If the money multiplier decreases what effect does this have on the money supply?

c.)    Suppose the general public moves a significant amount of its deposits from demand deposits to savings deposits.  The reserve requirement on demand deposits is higher than on savings deposits.  What two effects would you expect this to have on the money supply as defined by M1?

d.)   What are the three monetary tools that the Fed can use to influence the money supply?  Which one is used most often?

7.     Alan Greenspan, the Chairman of the Federal Reserve, believes that the economy is currently in a deflationary gap.  (For this problem also assume that fiscal policy is constant).

a.)    If the Fed did not change monetary policy what would be the result in the long run?

b.)   What would be the appropriate monetary policy for the Fed to use?  Explain, using the appropriate graphs, what would happen to the interest rate, real GDP, and the general price level.


8.     Assume that the economy is currently at a long-run equilibrium (i.e., at potential GDP).

a.)    Explain and graphically show the effects on the price level and real GDP of an unanticipated increase in the money supply.  Also, show what effects this would have in the labor market on wages and employment.

b.)   Assume that once again the economy is initially at a long-run equilibrium.  Explain and graphically show the effects on the price level and real GNP of a fully anticipated increase in the money supply.  Also, show what effects this would have in the labor market on wages and employment.


9.  By the end of 1988 the annual inflation rate in Brazil was over 900%.  What would you expect has been happening to the money supply in Brazil?