Page 333 - Krugmans Economics for AP Text Book_Neat

Section 5 Summary

b.Salt was used in many European countries as a medium of deposits it holds until its level of reserves satisfies its re-
exchange. quired reserve ratio. The bank reduces its deposits by calling
c. For a brief time, Germany used paper money (the “Rye in some of its loans, forcing borrowers to pay back these
Mark”) that could be redeemed for a certain amount of rye, loans by taking cash from their checking deposits (at the
a type of grain. same bank) to make repayment.
d.The town of Ithaca, New York, prints its own currency, c. If every time the bank decreases its loans, checkable bank
Ithaca HOURS, which can be used to purchase local goods deposits fall by the amount of the loan, by how much will
and services. the money supply in the economy contract in response to
Ryan’s withdrawal of $400?
7. Indicate whether each of the following is part of M1, M2, or
d.If every time the bank decreases its loans, checkable
neither:
bank deposits fall by the amount of the loan and the
a. $95 on your campus meal card bank maintains a reserve ratio of 20%, by how much
b.$0.55 in the change cup of your car will the money supply contract in response to a with-
c. $1,663 in your savings account drawal of $400?
d.$459 in your checking account 12. In Westlandia, the public holds 50% of M1 in the form of cur-
rency, and the required reserve ratio is 20%. Estimate how
e. 100 shares of stock worth $4,000
much the money supply will increase in response to a new cash
f. a $1,000 line of credit on your Sears credit card
deposit of $500 by completing the accompanying table. (Hint:
8. You have won the state lottery. There are two ways in which The first row shows that the bank must hold $100 in mini-
you can receive your prize. You can either have $1 million in mum reserves—20% of the $500 deposit—against this deposit,
cash now, or you can have $1.2 million that is paid out as fol- leaving $400 in excess reserves that can be loaned out. How-
lows: $300,000 now, $300,000 in one year’s time, $300,000 in ever, since the public wants to hold 50% of the loan in cur-
two years’ time, and $300,000 in three years’ time. The interest rency, only $400 × 0.5 = $200 of the loan will be deposited in
rate is 20%. How would you prefer to receive your prize? round 2 from the loan granted in round 1.) How does your an-
swer compare to an economy in which the total amount of the
9. The drug company Pfizer is considering whether to invest in
loan is deposited in the banking system and the public doesn’t
the development of a new cancer drug. Development will re-
hold any of the loan in currency? What does this imply about
quire an initial investment of $10 million now; beginning one
the relationship between the public’s desire for holding cur-
year from now, the drug will generate annual profits of $4 mil-
rency and the money multiplier?
lion for three years.
a. If the interest rate is 12%, should Pfizer invest in the devel-
Required Excess Held as
opment of the new drug? Why or why not?
Round Deposits reserves reserves Loans currency
b.If the interest rate is 8%, should Pfizer invest in the develop-
ment of the new drug? Why or why not? 1 $500.00 $100.00 $400.00 $400.00 $200.00
2 200.00 ? ? ? ?
10. Tracy Williams deposits $500 that was in her sock drawer into
a checking account at the local bank. 3 ? ? ? ? ?
a. How does the deposit initially change the T-account of the 4 ? ? ? ? ?
local bank? How does it change the money supply? 5 ? ? ? ? ?
b.If the bank maintains a reserve ratio of 10%, how will it re- 6 ? ? ? ? ?
spond to the new deposit?
7 ? ? ? ? ?
c. If every time the bank makes a loan, the loan results in a
8 ? ? ? ? ?
new checkable bank deposit in a different bank equal to the
amount of the loan, by how much could the total money 9 ? ? ? ? ?
supply in the economy expand in response to Tracy’s initial 10 ? ? ? ? ?
cash deposit of $500? Total after
d.If every time the bank makes a loan, the loan results in a 10 rounds ? ? ? ? ?
new checkable bank deposit in a different bank equal to the
13. What will happen to the money supply under the following cir-
amount of the loan and the bank maintains a reserve ratio
cumstances in a checkable-deposits-only system?
of 5%, by how much could the money supply expand in re-
sponse to an initial cash deposit of $500? a. The required reserve ratio is 25%, and a depositor withdraws
$700 from his checkable bank deposit.
11. Ryan Cozzens withdraws $400 from his checking account at
the local bank and keeps it in his wallet. b.The required reserve ratio is 5%, and a depositor withdraws
$700 from his checkable bank deposit.
a. How will the withdrawal change the T-account of the local
bank and the money supply? c. The required reserve ratio is 20%, and a customer deposits
$750 to her checkable bank deposit.
b.If the bank maintains a reserve ratio of 10%, how will the
bank respond to the withdrawal? Assume that the bank re- d.The required reserve ratio is 10%, and a customer deposits
sponds to insufficient reserves by reducing the amount of $600 to her checkable bank deposit.

Summary 291