Answer Key to Unit 6 Assessment. 1. ... which is the maximum resultant change.
... changes in economic activity and achievement of macroeconomic goals. 10.
Answer Key to Unit 6 Assessment 1. The money multiplier, which is calculated as one divided by the required reserve ratio, equals 10.0 (1/0.10) in this instance. The money supply would grow by $10 billion, which is the maximum resultant change. The condition under which that change occurs assumes that all banks in the entire banking system are generating loans from their excess reserves. 2. M1 differs from M2 by the latter’s addition of the time dimension; M1 excludes accounts that earn interest. 3. For a graph depicting the bonds market, the label assigned to the vertical axis is the price of bonds and the label assigned to the horizontal axis is the quantity of bonds. The supply of bonds curve will slope upward, given the positive or direct relationship between price and quantity of bonds supplied. Open market operations is an action that alters the supply of bonds in which purchases will decrease the supply (a leftward shift) and sales will increase the supply (a rightward shift), holding all else constant. 4. Money serves as a medium of exchange, a store of value, and a unit of account. Those three functions enable individuals to avoid bartering and dealing with double coincidence of wants. 5. The three tools that the Federal Reserve uses as part of monetary policy are open market operations, discount rates, and required reserve ratios. The operations tool allows the Fed to buy and sell government securities. The discount rate tool allows member banks of the Federal Reserve System to borrow at a low interest rate from the Fed. The ratio tool sets the portion of new deposits that banks must keep in reserves, though they can loan the remainder of new deposits. The ratio is rarely changed because of its robust potential to expand or contract the supply of money and the money creation process. 6. Interest rates, which move in the opposite direction of bond prices, will increase in conjunction with a decrease in price following an increase in the supply of bonds, while holding all else constant. Likewise, interest rates will decrease in conjunction with an increase in price. It is also important to take note of the following complexities: interest rates relate to bond prices; open market sales relate to the shift in the bond supply curve; and only the price and the quantity of bonds appear in a graph depicting the bond market. 7. Your knowledge of macroeconomics at this junction should place you in a position to expect a decline in investment expenditures and an increase in consumer savings as a consequence of an increase in interest rates. The increase in savings means that consumer spending will decline, holding all else constant. A decrease in consumption expenditures, investment expenditures, or both will result in a decrease in AD and in GDP, holding all else constant.
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8. Total reserves are the checkable deposits that the public has placed in a commercial bank. Required reserves are a percentage of the checkable deposits that must remain in a commercial bank as required by the Federal Reserve. Required reserves are set by the Federal Reserve to protect banks from customers running on the bank, i.e., reserves protect a bank from customer panic. Excess reserves are a percentage of checkable deposits that a bank is authorized by the Federal Bank to lend out. Consequently, required reserves are deposits from which the banks earn a profit through the loan and repayment process. 9. The federal funds rate is applicable to loans that banks make to other banks, usually in order to comply with federal regulations, and is set by the banks. The targeted federal funds rate is set by the Fed. It provides signals about future interest rates to the market for the purpose of focusing on desired changes in economic activity and achievement of macroeconomic goals. 10. Exchange rates relate the price of a country’s own currency compared to the price of another country’s currency mainly for the purpose of international trade. Trading partners need to convert their own currency into that of the country from which imports originate. For example, when the United States imports vehicles from Japan, we pay for them in Yen and need to purchase that currency using US dollars. In essence, the demand for and supply of currencies determine the exchange rate. 11. Holders of both stocks and bonds tend to focus on changes in prices and attempt to sell at a price higher than the purchase price. A stock is a share of ownership in an organization, and its price is determined largely by the supply of and the demand for stocks in the stock market. Unlike stocks, bonds take the form of loans. An inverse relationship exists between bond prices and interest rates. 12. The main differences between the perspectives and main points of the Classics and Keynesians center on the role of government in an economy and on the conditions for equilibrium. The latter group contends that equilibrium occurs when unemployment exists. In addition, the Keynesians contend that government has an active role in the economy especially during periods of high unemployment and high inflation. The Monetarists are comparable to the Classics, though they focus on how government handles a nation’s monetary base and money supply. 13. Much of the debate between Keynesians and Monetarists is centered on the latitude held by the Fed, especially in expanding the supply of money. The Classics and Monetarists have concerns about the connection of money to inflation and favor a rules laden approach to monetary policy, which places limits on the Fed’s ability to manage the macroeconomy. Debates from the Monetarists tend to center on restricting monetary policy to rules including those declaring the future rate of growth in the money supply. Keynesians and others tend to argue for the precise opposite, contending the Fed needs maximum flexibility in managing the economy and various expectations.
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