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Section 5 Test Review
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Share of ownership in a corporation
What is a stock? Share of ownership in a corporation
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What is a bond? IOU that pays interest
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What is investment spending? Example.
Business spending on productive equipment
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What is a budget surplus?
Tax revenue greater than spending
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What is a budget deficit?
Spending greater than tax revenue
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What function do banks perform?
direct savings to investment
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real estate, long term bonds/savings
What is liquidity? What assets are the most liquid? Cash/currency What assets are least liquid? real estate, long term bonds/savings
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Asset that can buy goods and services
How do we define money? Asset that can buy goods and services
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What are the three main functions that money performs?
Medium of exchange Unit of account Store of value
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Derives value from government order (e.g. US dollar)
What is fiat money? Derives value from government order (e.g. US dollar)
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What is in the M1 money supply?
Most liquid Currency Checkable deposits Traveler’s checks
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What is in the M2 money supply?
Savings accounts CDs
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Given a present dollar value and a certain rate of interest, how does one calculate future value?
$Y x (1 + r)
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What is the required reserve ratio?
Amount banks must set aside as vault cash/reserves at Fed
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If Zeke makes a $1,000 deposit into his checking account, what happens to the money supply initially? No change
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Excess reserves x money multiplier (5)
If the reserve requirement is 20%, what is the eventual impact of Zeke’s deposit on the money supply? Excess reserves x money multiplier (5)
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How do banks create money?
Make loans
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What is the formula for the money multiplier?
1/res. Req.
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How are the reserve ratio and the money multiplier related?
inversely
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ASSETS LIABILITIES Loans $80 $100 Reserves $20
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Using chart above, how will an additional $100 deposit affect the banks excess reserves?
Increase $80
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Using chart above, how will the deposit affect the money supply?
Increase $400
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List the three expansionary monetary policy options?
Buy bonds Lower discount rate Lower reserve requirement
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When does the Fed want to implement expansionary policy?
In recession
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List the three contractionary monetary policy options?
Sell bonds Raise discount rate Raise reserve requirement
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When does the Fed want to implement contractionary policy?
Inflation
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If the Fed lowered the reserve requirement from 10% to 5%, then the money multiplier would go from to . 10 to 20
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What is the Federal Funds Rate?
Bank to bank interest rate
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What is the main responsibility of the Fed?
Control the money supply
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What are open market operations?
Fed buying and selling bonds/treasuries/securities
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What OMO is appropriate to combat inflation?
SELL bonds
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What OMO is appropriate to combat a recession?
BUY/PURCHASE bonds
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$500 billion ($100 billion x 1/.2)
If the Fed BUYS or purchases $100 billion in bonds with a 20% reserve requirement, the total change to the money supply will be $500 billion ($100 billion x 1/.2)
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SELL $5 billion of bonds ($20 billion/4)
If actual GDP is $150 billion and potential GDP is $130 billion, what could the Fed do to close the gap with a reserve requirement of 25%? SELL $5 billion of bonds ($20 billion/4)
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How will an open market SALE of bonds/securities affect:
Bank reserves - decrease Money supply - decrease Interest rates - increase Investment spending - decrease Growth - decrease
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How will an open market PURCHASE of bonds/securities affect:
Bank reserves - increase Money supply - increase Interest rates - decrease Investment spending - increase Growth - increase
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Using a correctly-labeled graph of the MONEY MARKET, show the effect of an open market SALE of bonds/securities on interest rates.
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Using a correctly-labeled graph of the LOANABLE FUNDS MARKET, show the effect of an expansionary FISCAL POLICY.
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Interest rates – increase Investment – decrease Growth - decrease
How will this affect interest rates, investment spending and economic growth? Interest rates – increase Investment – decrease Growth - decrease
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