Macroeconomics ch. 16-17 Test

What is money?

A set of assets in an economy that people regularly use to buy goods and services.

What are the three functions of money?

Medium of exchange, Unit of account, Store of value

What is a medium of exchange?

An item buyers give to sellers to purchase goods and services.

What is a unit of account?

A measure used to post prices and record debts.

What is a store of value?

Something people use to transfer purchasing power into the future.

What is liquidity?

How easily an asset can be converted into money.

What is commodity money?

Money with intrinsic value (ex: gold coins).

What is fiat money?

Money without intrinsic value that is accepted because the government declares it as money.

What is the money stock?

The total amount of money circulating in the economy.

What does M1 include?

Currency, Demand deposits, Other liquid deposits

What does M2 include?

Everything in M1 plus: Small time deposits, Money market funds

What is a central bank?

An institution that oversees the banking system and regulates the money supply.

What is the Federal Reserve (Fed)?

The central bank of the United States.

What is monetary policy?

The setting of the money supply by the central bank.

What is the Federal Open Market Committee (FOMC)?

The group that sets monetary policy and meets about every 6 weeks.

What are bank reserves?

Deposits banks receive but have not loaned out.

What is fractional-reserve banking?

A system where banks keep only a fraction of deposits as reserves.

What is the reserve ratio?

The fraction of deposits banks hold as reserves

What is the money multiplier?

The amount of money created from each dollar of reserves.

What is the formula for the money multiplier?

Money Multiplier = 1 / Reserve Ratio

What are open-market operations?

The Fed buying or selling government bonds to change the money supply.

What happens when the Fed buys government bonds?

The money supply increases.

What happens when the Fed sells government bonds?

The money supply decreases.

What is the discount rate?

The interest rate the Fed charges banks for loans.

What is the federal funds rate?

The interest rate banks charge each other for overnight loans.

What is inflation?

An increase in the overall level of prices.

What is deflation?

A decrease in the overall level of prices.

What is hyperinflation?

An extremely high inflation rate.

What is the quantity theory of money?

The idea that the amount of money determines the price level and inflation.

What is velocity of money?

The rate at which money changes hands.

What is the quantity equation?

M × V = P × Y

What do the variables in the quantity equation represent?

M = money supply
V = velocity
P = price level
Y = real GDP

What is the real interest rate formula?

Real Interest Rate = Nominal Interest Rate − Inflation

What is the Fisher Effect?

When inflation increases, nominal interest rates increase as well.

What are shoeleather costs?

Costs from reducing money holdings due to inflation.

What are menu costs?

Costs businesses face when changing prices.

What is the inflation tax?

The loss of purchasing power caused by printing money.

Why does unexpected inflation cause problems?

It redistributes wealth between borrowers and lenders.

How can investors reduce risk?

By diversifying — placing many small investments instead of a few large ones and holding many stocks.

If a stock is overvalued, what does that mean?

Its present value is less than its market price, so you should not add it to your portfolio.

What does beta measure in finance?

A stock’s sensitivity to market risk.

What is the formula used in CAPM to find the required return?

Required return = Risk-free rate + Beta × Market risk premium

What does the efficient markets hypothesis suggest?

Asset prices reflect all available information.

According to efficient markets, stock prices should follow what pattern?

A random walk.

Why is studying business pages unlikely to consistently beat the market?

Because information is already reflected in stock prices.

If George has $95 after earning 4% interest for one year, how much did he originally deposit?

$91.35

Heidi deposits $250 and has $270 after one year. What was the interest rate?

8%

Which asset is most liquid?

Currency.

Rank these from most to least liquid: currency, stocks, fine art.

Currency - Stocks - Fine art.

If gold were used as money, what type of money would it be?

Commodity money.

Who are always voting members of the FOMC?

Board of Governors (7 members),New York Fed president

Which regional Fed president is not always a voting member?

Boston Fed president.

When a bank makes a loan, how does it affect the money supply?

It increases the money supply.

If the reserve ratio is 8%, what is the money multiplier?

Multiplier = 1 / 0.08 = 12.5

If banks receive $1,000 in new reserves with an 8% reserve ratio, how much can money supply increase?

$12,500

What Fed action increases the money supply?

Open market purchases (buying bonds).

What happens if the Fed lowers the reserve requirement?

Money multiplier increases, Money supply increases

What happens if banks hold more excess reserves?

Money multiplier decreases, Money supply decreases

During a bank run, what happens to the money supply?

It decreases because people hold more currency and banks hold more reserves.

If the price level rises from 120 to 150, what is the inflation rate?

Inflation = (150 − 120) / 120 = 25%

What does nominal GDP measure?

The dollar value of all final goods and services produced.

What does real GDP measure?

The quantity of goods and services produced, adjusted for inflation.

According to the classical dichotomy, what happens when the money supply increases?

Only nominal variables change, not real variables.

What is the formula for velocity of money?

V = (P × Y) / M

When money is neutral, increasing money supply growth increases what?

Nominal interest rates.

If inflation is higher than expected, who benefits?

Debtors benefit and creditors lose.