QUESTIONS AND PROBLEMS

Check Your Understanding

Question 11.1

1. Describe the three functions of money.

Question 11.2

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

Question 11.3

3. Explain the important difference between M1 and M2.

Question 11.4

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

Question 11.5

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

Question 11.6

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

Apply the Concepts

Question 11.7

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.

Question 11.8

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?

Question 11.9

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?

Question 11.10

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.

Question 11.11

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?

Question 11.12

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

In the News

Question 11.13

13. A proposal in the government budget set forth in 2016 placed a limit on the total amount of savings that can be accumulated in tax-preferred retirement accounts to $3.4 million. The White House has argued that wealthy individuals have accumulated “tax-preferred retirement savings sufficient to finance an annual income of over $200,000 per year in retirement,” 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?

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Question 11.14

14. The U.S. stock market doubled in value between 2010 and 2016. However, a slowdown in economic growth in many countries, increased volatility in stock markets, and an anticipated rise in U.S. interest rates have led some analysts to believe bonds may outperform stocks. If more investors switch from buying stock to bonds, how might this lead to a self-fulfilling prophecy? Does this argument reflect the theory of the tradeoff between risk and return?

Solving Problems

Question 11.15

15. 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.

WORK IT OUT | interactive activity

Question 11.16

16. The yield for a perpetuity bond is determined by the simple formula

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  1. Calculate the yield on a $1,000 perpetuity bond that pays $40 a year forever to the bondholder.

  2. Suppose that actions taken by the Fed cause interest rates in the economy to fall by 2%. How will this affect the price of the bond that still pays $40 a year in interest?

  3. Now suppose that one purchases a new $1,000 perpetuity bond at the lower interest rate. What will the annual interest payment be equal to?

  4. If interest rates were to rise back to the original level determined in part (a), how will that affect the price of the new bond purchased in part (c)?

USING THE NUMBERS

Question 11.17

17. According to By the Numbers, which bank had the largest amount of assets in 2015, and what was this value? How much in assets did a bank need to reach the top ten largest banks in the world in 2015?

Question 11.18

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.