chapter 5 quiz

1.  If the reserve ratio is .2 and there is an increase in demand deposits of $1,000.00, the maximum increase in the money supply is?

E.  $5,000
change in MS = change in DD x money multiplier where MS is money supply and DD is demand deposits.
The money multiplier is 1/r where r is the reserve ratio.
The reserve ratio is the percent of DD that has to be retained in the bank, i.e., it can't be loaned out.
So, the change in MS = $1,000 x 1/r = $1,000 x 1/.2 = $1,000 x 5 = $5,000


2.  If people hold 20% of their money in currency, what would be the increase in the money supply using the data from question 1?

E.  None of the above

In this case we use the same equation in #1, but the money multiplier is (1+c)/(r+c) which is the real world money multiplier.
In #1 we used the simple monmey multiplier because there was no cash held by people.
Substituting into the equation gives us change in MS = $1,000 x (1+c)/(1+r) = $1,000 x (1+.2)/(.2+.2) =$1,000 x 1.2/.4 = $1,000 x 3 = $3000.00


3.  Does using a credit card increase the money supply?

B.  No

4.  M2 includes all of the following EXCEPT

A.  M1
B.  Savings deposits
C.  Small-denomination time deposits
D.  All short-term assets
E.  None of the above

5.  M1 is about 2 times larger than M2.

A.  True
B.  False

6.  Money serves as a

A.  Medium of exchange
B.  Unit of account
C.  Store of wealth
D.  All of the above
E.  None of the above

7.  Cash is not an example of a liquid financial asset.

B.  False
8.  Liquid assets are most able to perform which of the following functions?

A.  Medium of exchange

9.  If people hold more cash than previously, the money multiplier (real world) increases.

B.  False

10.  What is the money multiplier if people hold 25% of their money in cash and the reserve ratio is 5%?

A.  30
B.  20
C.  10
D.  5
E. None of the above

Substituting into the real world money multiplier equation gives us (1+.25)/(.05+.25) = 1.25/.30 = 4.16

11.  What is the simple money multiplier if people hold no cash and the reserve ratio is 5%?

B.  20
Substituting into the simple money multiplier equation of 1/r gives us 1/.05 = 20, hence answer B.


12.  As the interest rate rises, the price of bonds

C.  Decreases
It is P = (bond value + bond interest)/ (1 + r)
If the bond value is $1,000 and it pays 6% per year or $40 per year and the interest rate in the economy is 4% then the price of the bond is P = ($1,000 + $40) / 1 + .06) = $1,040/1.06 = $981.13

13.  If you are worried that you may need extra cash to pay for AC repairs given your AC unit is old and inefficient, then you would hold cash for the:

D.  Precautionary motive
14.  If the money supply decreased by $4,000 and the reserve requirement rate is 10%, what was the change in demand deposits?

B.  -$400
It is change in MS = change in DD x 1/r
 substituting into the equation gives us -$4,000 = change in DD x 1/.1 = change in DD x 10. To get the change in DD we have to divide each side of the equation by 10, so -$400 = change in DD.


15.  If the currency-to-deposit ratio is 0.15 and the reserve ratio is 0.05, then the money multiplier will be:

E.  None of the above
The currency-to-deposit ratio is the same thing as cash on hand.
So using the real world money multiplier of (1+c)/(r+c) and substituting into it we get (1+.15)/(.05+.15) = 1.15/.20 = 5.75