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Exam 10: The Financial Sector and the Economy

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Question 1

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The three functions of money are to serve as: (1) a medium of exchange, (2) a unit of account, and (3) a store of wealth.Briefly explain each of these functions and give an example of each.

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(1) The medium of exchange function refe...

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Question 2

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Explain the difference between the way real assets are created and the way financial assets are created.

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Real assets are created by real economic...

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Why is money important from a short-run macroeconomic perspective?

What is money? What is a liquid financial asset? Why do people hold their assets in the form of money?

A story often told about the emergence of banks is that banks first emerged from the activities of goldsmiths, who stored gold for a fee.Briefly describe this story.

All M1 assets are included in M2.We will call those assets that are part of M2 but not part of M1, "M2 assets".You have just received $5,000 that you must hold as either an M1 asset or an M2 asset.What are the costs and benefits of holding the $5,000 as an M1 asset rather than as an M2 asset? Explain.

What is money? What are the three functions of money?

John Deere deposits $1,000 into Lawnmowers Community National Bank.Suppose banks hold reserves of 10% and people hold no currency outside of banks.What will be the amount of new money the banking system can create as a result of John's deposit?

You are holding two bonds; one matures in 1 year and the other matures in 30 years.What do you expect to happen to the price of each bond when the interest rate rises? For which bond will the effect of a change in interest rates be greater?

What does it mean to say that money is liquid?

Economists use the terms save and invest in a way that is somewhat different from their common language usage.Explain the special meaning of these terms as used by economists.

What are M1 and M2?

Define financial assets, and explain why every financial asset must correspond to a financial liability.

Why is the financial sector important in macroeconomic debates?

What is the relationship between the real side of the economy (economic activity that results in the creation of real assets) and the financial side of the economy (economic activity that results in the production of financial assets)? Your discussion should cover the following points: How does the production of real assets differ from the production of financial assets? Does the creation of financial assets really contribute to overall economic productivity? Do financial assets make a country richer or poorer? What role do financial assets serve (if any) in facilitating the production of real assets?

"Credit cards make a difference in how much money people hold, but they are not money." Explain this statement.

Why is it not the case that changes in reserves are certain to cause changes in the money supply?

Explain the distinction between a real transaction and a financial transaction (giving examples of each) and explain why for most real transactions, there is a financial transaction that mirrors it.

Demonstrate equilibrium in the money market.Why does the demand curves have the slopes as you have drawn them? How does an increase in the demand for money affect the short-term interest rate?

Explain how banks create money.Compare the effect on the money supply of accepting a cash deposit with that of making a loan.