Summary 291
b.Salt was used in many European countries as a medium of
exchange.
c.For a brief time, Germany used paper money (the “Rye
Mark”) that could be redeemed for a certain amount of rye,
a type of grain.
d.The town of Ithaca, New York, prints its own currency,
Ithaca HOURS, which can be used to purchase local goods
and services.
7.Indicate whether each of the following is part of M1, M2, or
neither:
a.$95 on your campus meal card
b.$0.55 in the change cup of your car
c.$1,663 in your savings account
d.$459 in your checking account
e.100 shares of stock worth $4,000
f.a $1,000 line of credit on your Sears credit card
8.You have won the state lottery. There are two ways in which
you can receive your prize. You can either have $1 million in
cash now, or you can have $1.2 million that is paid out as fol-
lows: $300,000 now, $300,000 in one year’s time, $300,000 in
two years’ time, and $300,000 in three years’ time. The interest
rate is 20%. How would you prefer to receive your prize?
9.The drug company Pfizer is considering whether to invest in
the development of a new cancer drug. Development will re-
quire an initial investment of $10 million now; beginning one
year from now, the drug will generate annual profits of $4 mil-
lion for three years.
a.If the interest rate is 12%, should Pfizer invest in the devel-
opment of the new drug? Why or why not?
b.If the interest rate is 8%, should Pfizer invest in the develop-
ment of the new drug? Why or why not?10.Tracy Williams deposits $500 that was in her sock drawer into
a checking account at the local bank.
a.How does the deposit initially change the T-account of the
local bank? How does it change the money supply?
b.If the bank maintains a reserve ratio of 10%, how will it re-
spond to the new deposit?
c.If every time the bank makes a loan, the loan results in a
new checkable bank deposit in a different bank equal to the
amount of the loan, by how much could the total money
supply in the economy expand in response to Tracy’s initial
cash deposit of $500?
d.If every time the bank makes a loan, the loan results in a
new checkable bank deposit in a different bank equal to the
amount of the loan and the bank maintains a reserve ratio
of 5%, by how much could the money supply expand in re-
sponse to an initial cash deposit of $500?
11.Ryan Cozzens withdraws $400 from his checking account at
the local bank and keeps it in his wallet.
a.How will the withdrawal change the T-account of the local
bank and the money supply?
b.If the bank maintains a reserve ratio of 10%, how will the
bank respond to the withdrawal? Assume that the bank re-
sponds to insufficient reserves by reducing the amount of
deposits it holds until its level of reserves satisfies its re-
quired reserve ratio. The bank reduces its deposits by calling
in some of its loans, forcing borrowers to pay back these
loans by taking cash from their checking deposits (at the
same bank) to make repayment.
c.If every time the bank decreases its loans, checkable bank
deposits fall by the amount of the loan, by how much will
the money supply in the economy contract in response to
Ryan’s withdrawal of $400?
d.If every time the bank decreases its loans, checkable
bank deposits fall by the amount of the loan and the
bank maintains a reserve ratio of 20%, by how much
will the money supply contract in response to a with-
drawal of $400?
12.In Westlandia, the public holds 50% of M1 in the form of cur-
rency, and the required reserve ratio is 20%. Estimate how
much the money supply will increase in response to a new cash
deposit of $500 by completing the accompanying table. (Hint:
The first row shows that the bank must hold $100 in mini-
mum reserves—20% of the $500 deposit—against this deposit,
leaving $400 in excess reserves that can be loaned out. How-
ever, since the public wants to hold 50% of the loan in cur-
rency, only $400 ×0.5=$200 of the loan will be deposited in
round 2 from the loan granted in round 1.) How does your an-
swer compare to an economy in which the total amount of the
loan is deposited in the banking system and the public doesn’t
hold any of the loan in currency? What does this imply about
the relationship between the public’s desire for holding cur-
rency and the money multiplier?13.What will happen to the money supply under the following cir-
cumstances in a checkable-deposits-only system?
a.The required reserve ratio is 25%, and a depositor withdraws
$700 from his checkable bank deposit.
b.The required reserve ratio is 5%, and a depositor withdraws
$700 from his checkable bank deposit.
c.The required reserve ratio is 20%, and a customer deposits
$750 to her checkable bank deposit.
d.The required reserve ratio is 10%, and a customer deposits
$600 to her checkable bank deposit.Section 5 SummaryRequired Excess Held as
Round Deposits reserves reserves Loans currency
1 $500.00 $100.00 $400.00 $400.00 $200.00
2 200.00????
3?????
4?????
5?????
6?????
7?????
8?????
9?????
10?????
Total after
10 rounds?????