Answers to Exercises

1. Money is a medium of exchange, which means that money is used to carry out transactions. I take dollars to the grocery store to buy food. Money is a unit of account, which means that goods are valued in terms of money. In the United States, goods are priced in dollars. Money is a store of value, meaning that a person can use money to maintain purchasing power over time. I have $100 in my purse, which I will use next week to pay my rent. Money is a standard of deferred payment, which means that debt obligations are denominated in money terms. My student loan is denominated in U.S. dollars, and I will use U.S. dollars to repay the loan.

2. a. In the form of coins, gold can be used in exchange, although large transactions are cumbersome. Gold also can store value over time as well.

b. Yap stone money serves all the functions of money because of the agreements that people have made in exchanging the money for goods. With these agreements, Yap stone money serves as a medium of exchange and as a store of value.

c. Cigarettes can also serve all of the functions of money, although they may not serve the store of value function as well as they serve other forms if the money holder is a smoker. Because transactions can be carried out with cigarettes, the cigarettes can serve as a medium of exchange.

d. Diamonds can also serve the functions of money, although the medium of exchange function may be inhibited, especially in small transactions. Diamonds may serve the store of value and unit of account functions of money.

3. A financial intermediary is a business firm like a bank, credit union, or savings and loan institution that accepts deposits and makes loans. My bank accepts my deposits, which I may need back on very short notice, and then makes long-term loans to borrowers who need a long time for repayment. Alternatively, I may borrow from my bank to buy a car. My bank gives me four years to pay back the loan. The bank funds my loan with money it accepts in deposits from other individuals.

4. The Eurocurrency market is where deposits and loans are denominated in currencies other than the domestic currency. Such banking exists outside the domestic banking industry. The Eurocurrency market is largely unregulated with respect to reserve requirements, taxes are lower for international banks, and there is no deposit insurance.

5. IBFs are on-shore international banks. These are not actually banks but are separate bookkeeping systems that record a bank's international deposits and loans. IBFs were probably legalized to capture some of the international banking business that was going offshore.

6. a.

b. The bank must maintain reserves of $120,000 against its deposits of $1,000,000. It can therefore make additional loans totaling $80,000.

c. The maximum amount that the money supply can increase is $80,000/.12 = $666,666.66

7. a. The bank can lend an amount equal to (1 - .02) ( $5,000) = $4,900

b. The deposit multiplier = 1/.02 =50.

The banking system can expand the money supply by $4,900 (50 )= $245,000

8. Because M2 includes assets that incorporate potential spending and that are still quite liquid, it is a better measure of the money supply. In the 1980s, M2 more accurately predicted the price level and nominal gross domestic product than M1 did.

9. If people choose to hold cash rather than checkable deposits, the deposit multiplier will be smaller. Also, if banks choose to hold excess reserves, they will not lend as much at each stage in the multiplier process. Consequently, the deposit multiplier will be smaller.

10. The liquidity of an asset is how easily the asset can be exchanged for goods and services. In order of liquidity: $10 bill, travelers' checks, personal check for $20, savings account with $400 in it, stereo, car, and house.

11. M1: $100 + $2,000 + $5,000 + $9,000 = $16,100

12. M2: $16,100 + $7,500 + $3,500 = $27,100

13. M3: $27,100 + $2,000 + $8,000 = $37,100

14. a. 1/.1 = 10

b. = 5

Answers to Study Guide Homework

1. Anything that is generally acceptable to sellers in exchange for goods and services.

2. Medium of exchange, unit of account, store of value, standard of deferred payment

3. Currency, traveler's checks, demand deposits, other checkable deposits

4. Making loans

5. a. Excess reserves = $9,500: the $10,000 deposit - $500 required reserves (5% of $10,000). The bank can loan up to $9,500.
b. Excess reserves = $9,025: the $9,500 deposit - $475 required reserves. The bank can loan up to $9,025.
c. Deposit expansion multiplier = 20 (1/.05). Including the initial $10,000, the money supply can expand by $200,000 (20 times $10,000).

Answers to Internet Exercise

This exercise will help students explore information provided by the FDIC regarding bank failures. It will also help students place in perspective the relative size of failed banks. Have students refer to Figure 3 in the chapter and discuss the trends in bank failures.

Solutions are based on 1996 information and will need to be updated as time passes.

1996; 5

PA, TX (2), CT, CA; TX seems to have particularly high numbers.

$67,968,000; First National Bank of the Panhandle - Panhandle, TX

$10,883,000; Fairfield First Bank and Trust Co.

Small