Questions and Problems

1. Question

   Describe the three functions of money.

   Prob 22 1. Describe the three functions of money.

2. Question

   What is a barter economy? Describe why such an approach is a difficult way for a modern economy to exist.

   Prob 22 2. What is a barter economy? Describe why such an approach is a difficult way for a modern economy to exist.

3. Question

   Explain the important difference between M1 and M2.

   Prob 22 3. Explain the important difference between M1 and M2.

4. Question

   What gives our money its value if there is no gold or silver backing the currency?

   Prob 22 4. What gives our money its value if there is no gold or silver backing the currency?

5. Question

   What happens to savings if the real interest rate goes up? What happens to the demand for borrowing?

   Prob 22 5. What happens to savings if the real interest rate goes up? What happens to the demand for borrowing?

6. Question

   Explain why bond prices and interest rates are inversely related.

   Prob 22 6. Explain why bond prices and interest rates are inversely related.

Apply the Concepts

7. Question

   List the following assets from most liquid to least liquid: a house (real estate); cash; a one-carat diamond; a savings account; 100 shares of Google stock; a Harley-Davidson motorcycle; a checking account; your old leather jacket.

   Prob 22 7. List the following assets from most liquid to least liquid: a house (real estate); cash; a one-carat diamond; a savings account; 100 shares of Google stock; a Harley-Davidson motorcycle; a checking account; your old leather jacket.

8. Question

   At many game centers (such as Chuck E. Cheese’s), it is common for kids to play carnival-type games to win prize tickets, which are then redeemed for a variety of prizes based on the number of tickets earned. In what ways do these prize tickets illustrate the three functions of money?

   Prob 22 8. At many game centers (such as Chuck E. Cheese’s), it is common for kids to play carnival-type games to win prize tickets, which are then redeemed for a variety of prizes based on the number of tickets earned. In what ways do these prize tickets illustrate the three functions of money?

9. Question

   How do recessions affect the market for loanable funds? What happens to the supply of savings? What happens to the demand for borrowing? What is the effect on real interest rates?

   Prob 22 9. How do recessions affect the market for loanable funds? What happens to the supply of savings? What happens to the demand for borrowing? What is the effect on real interest rates?

10. Question

    Most individuals with average wealth choose to save their money using a financial intermediary such as a bank or a mutual fund. However, individuals with greater wealth are more likely to invest in individual stocks or directly in new or existing businesses. Explain why persons of different wealth are likely to show differences in how they save, and how financial intermediaries play a role.

    Prob 22 10. Most individuals with average wealth choose to save their money using a financial intermediary such as a bank or a mutual fund. However, individuals with greater wealth are more likely to invest in individual stocks or directly in new or existing businesses. Explain why persons of different wealth are likely to show differences in how they save, and how financial intermediaries play a role.

11. Question

    Why would it be better to put $1,000 each year into a retirement account than to wait ten years and put in $10,000 all at once? Would it make much of a difference in the long run?

    Prob 22 11. Why would it be better to put $1,000 each year into a retirement account than to wait ten years and put in $10,000 all at once? Would it make much of a difference in the long run?

12. Question

    Why have pensions become a less common form of retirement benefit offered by companies?

    Prob 22 12. Why have pensions become a less common form of retirement benefit offered by companies?

In the News

13. Question

    A proposal in the government budget set forth in 2013 placed a limit on the total amount of savings that can be accumulated in tax-preferred retirement accounts to about $3 million (U.S. News and World Report, April 10, 2013). The White House has argued that wealthy individuals have accumulated “substantially more than is needed to fund reasonable levels of retirement saving,” and that the tax deductions from these excess savings cost the government billions each year. How do these sorts of proposals affect the market for loanable funds?

    Prob 22 13. A proposal in the government budget set forth in 2013 placed a limit on the total amount of savings that can be accumulated in tax-preferred retirement accounts to about $3 million (U.S. News and World Report, April 10, 2013). The White House has argued that wealthy individuals have accumulated “substantially more than is needed to fund reasonable levels of retirement saving,” and that the tax deductions from these excess savings cost the government billions each year. How do these sorts of proposals affect the market for loanable funds?

14. Question

    At the trough of the last recession in 2009, major stock market indexes had dropped in half from their peak in 2007. This led many stock analysts to argue that bonds had outperformed stocks and also were safer investments. However, a report published by Morningstar Investment Management titled “Are Bonds Going to Outperform Stocks Over the Long Run? Not Likely” contradicted these analysts by comparing returns on stocks and bonds over periods of more than 40 years, and showing that stock returns easily beat those of bonds. Why would the argument that bonds perform better than stocks lead to a self-fulfilling prophecy if investors sell stocks and buy bonds? Which argument better reflects the theory of the tradeoff between risk and return?

    Prob 22 14. At the trough of the last recession in 2009, major stock market indexes had dropped in half from their peak in 2007. This led many stock analysts to argue that bonds had outperformed stocks and also were safer investments. However, a report published by Morningstar Investment Management titled “Are Bonds Going to Outperform Stocks Over the Long Run? Not Likely” contradicted these analysts by comparing returns on stocks and bonds over periods of more than 40 years, and showing that stock returns easily beat those of bonds. Why would the argument that bonds perform better than stocks lead to a self-fulfilling prophecy if investors sell stocks and buy bonds? Which argument better reflects the theory of the tradeoff between risk and return?

Solving Problems

15. Question

    Suppose a small country has the following monies in circulation:
    
    Cash/currency: $1 million
    Demand deposits: $2 million
    Other checkable deposits: $2 million
    Small-denomination time deposits: $4 million
    Savings deposits: $5 million
    Money market deposit accounts: $5 million
    Calculate the value of M1 and M2 for this country.

    Prob 22 15. Suppose a small country has the following monies in circulation:Cash/currency: $1 millionDemand deposits: $2 millionOther checkable deposits: $2 millionSmall-denomination time deposits: $4 millionSavings deposits: $5 millionMoney market deposit accounts: $5 millionCalculate the value of M1 and M2 for this country.

16. Question

    Suppose you paid $1,000 for a perpetuity bond that pays $40 a year forever to the bondholder. Now suppose that due to aggressive policy by the Fed, general interest rates fall from 4% to 1%. What would be the price of the bond if it continues to pay $40 per year?

    Prob 22 16. Suppose you paid $1,000 for a perpetuity bond that pays $40 a year forever to the bondholder. Now suppose that due to aggressive policy by the Fed, general interest rates fall from 4% to 1%. What would be the price of the bond if it continues to pay $40 per year?

17. Question

    According to By the Numbers, which bank had the largest amount of assets in 2012, and what was this value? How much in assets did a bank need to reach the top ten largest banks in the world in 2012?

    Prob 22 17. According to By the Numbers, which bank had the largest amount of assets in 2012, and what was this value? How much in assets did a bank need to reach the top ten largest banks in the world in 2012?

18. Question

    According to By the Numbers, how much in U.S. dollars is currently in circulation in the world? How much in U.S. dollars is held in reserves in the world? Describe how these numbers compare to the euro and the Japanese yen.

    Prob 22 18. According to By the Numbers, how much in U.S. dollars is currently in circulation in the world? How much in U.S. dollars is held in reserves in the world? Describe how these numbers compare to the euro and the Japanese yen.