MODULE: MACROECONOMICS

BB106
Unit 6: Money and Banking
TUTORIAL
6

Short-answer Problems

1. Why can’t food be used as a form of money?

Answer:
Food is not a good store of value, as food can become stale and decay.

2. Discuss three major points about what gives money its value.

Answer:
 First, currency and demand deposits are considered money because these items are accepted as
payment for goods and services. Money must be acceptance to serve its function as a medium of
exchange.
 Second, the government mandates through law that paper money be accepted as payment for a
debt. While checks are not mandated by law as money, government agencies do back demand
deposits at banks with deposit insurance that helps to maintain the acceptability of this form of
money.
 Third, money is relatively source. There is a reasonably constant demand for money for
transactions purposes and future uses. The supply of money will determine the value or
‘purchasing power’ of each unit of money. The supply of money is controlled by monetary
institutions (the Federal Reserve System) that attempt to maintain a reasonably stable purchasing
power for money.

3. What are the functions of the Central Bank? Which one is most important?

Answer:

The most important function of the Central Bank is its role in regulating the money supply (service
functions for commercial banks, banker’s bank, bank for the government, manages transactions with other
countries, lenders of last resort, maintains banking stability).

4. Answer the next question based on the following consolidated balance sheet for the commercial
banking system. Assume the required reserve ratio is 25%. All figures are in billions of dollars.
Assets Liabilities + Net Worth

Reserves $100 Checkable deposits $300

Securities 200 Stock shares 700

Loans 100

Property 600

(a) What is the amount of excess reserves in this commercial banking system?
(b) What is the maximum amount that the money supply can be expanded?
 (c) If the reserve ratio fell to 20%, what is now the maximum amount that the money supply
can be expanded?
Answer:
(a) Required reserve are $75 billion ($300 × 0.5). Actual reserve is $100 billion, so excess reserves
are $25 billion ($100 billion - $75 billion).
(b) The monetary multiplier is 1/0.25 or 4. Maximum expansion of the money supply is $100 billion
($25 billion × 4).
(c) If the reserve ratio was 20%, then reserves would be $40 billion [$100 billion – (0.20 × $300
billion]. The monetary multiplier would be 1/0.20 or 5, so the maximum expansion of the money
supply is $200 billion ($40 billion × 5).
True / False Questions

1) The M2 money supply is larger than the M1 money supply.

Answer: True

2) Excess reserves are the amount by which required reserves exceed actual reserves.

Answer: False

3) The monetary multiplier and the income multiplier are two ways of referring to the same
concept.

Answer: False

4) If the reserve requirement is 10 percent, the monetary multiplier will be 10.

Answer: True

5) If the reserve requirement is 20 percent, the monetary multiplier will be 4.

Answer: False

6) The higher the reserve requirement, the higher is the monetary multiplier.

Answer: False

Multi-Choice Questions

1. If you write a check on a bank to purchase a used Honda Civic, you are using money primarily
as:
A. a medium of exchange.
B. a store of value.
C. a unit of account.
D. an economic investment.

2. The amount that a commercial bank can lend is determined by its:

A. required reserves.
B. excess reserves.
C. outstanding loans.
D. outstanding checkable deposits.

3. The primary purpose of the legal reserve requirement is to:

A. prevent banks from hoarding too much vault cash.
B. provide a means by which the monetary authorities can influence the lending ability of
commercial banks.
C. prevent commercial banks from earning excess profits.
D. provide a dependable source of interest income for commercial banks.