Answer the following from the Problems Appendix in the back of your textbook on pp. 334-335Chapter 13: Questions 9 and 10Chapter 14: Questions 6, 8, and 9Chapter 15: Questions 1, 2, and 9Your completed Homework assignment should be at least three to four pages in length. All sources used, including the textbook, must be referenced; paraphrased and quoted material must have accompanying citations. All references and citations used must be in APA style.Textbook: McEachern, W. A. (2015). ECON macroeconomics (4th ed.). Stamford, CT: Cengage Learning.
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UNIT VII STUDY GUIDE
Money and Banking
Course Learning Outcomes for Unit VII
Upon completion of this unit, students should be able to:
7. Illustrate monetary theory using the money supply and demand model.
Money and the Financial System
Banking and the Money Supply
Monetary Theory and Policy
Why is using a debit card like using cash, but using a credit card is not. After your study of the chapters for
this unit, have you got a good answer yet? Why would the funds be different based only on type of card one
uses? Banks create money, remember how? When one thinks of money, remember that money is cash,
coins, and checkable sources, and checkable sources can be accessed via a debit card.
A discussion of money leads to two important terms: M1 and M2. M1 is composed of currency and checks, to
include travelers checks held by non-banks. The Federal Reserve makes the currency that is circulated.
M2 includes other entities such as savings deposits, time deposits, money market accounts, and other
monetary instruments that are near money. M2 often is estimated to be four times larger than M1.
Back to our original question about debit and credit cards, after a short-term review. M1 included debit cards
but not credit cards, and M2 included both credit and debit cards. You likely notice that the gas station
typically accepts both credit and debit cards equally.
What is the difference? The debit card is using ones own cash, and the debit card is a mechanism to access
ones money from the bank immediately and directly. It is most similar to paying cash. In fact, note that many
gas stations will give one a price reduction on gas if one pays with the debit card. Why? This is because the
gas station has to pay a fee to the credit card company.
On the other hand, a credit card means you do not have to repay the money to the bank until the credit card
payment is due. The transaction is essentially a loan that required acceptance of loan risk, and for a
transaction to occur between customer, gas station, and bank. Since the cash does not transfer immediately,
then there is non-payment risk that must be incurred by the bank, and typically a credit card fee the gas
station must pay to the credit-card vendor.
Consider interest rate as the price for money. Why does one say this? Assume that you lend me $100, which
means you forgo the use of this money while I am using it. We call this the opportunity cost because you
could have used it for something else, but lent it to me. You gave up your opportunity to use it for something
else. For the fact that you are giving up opportunity cost, you desire to be compensated. What price do you
set, or what interest rate should you charge? The interest rate charged would be the cost to you of your next
best use of the money, and we call this opportunity cost.
BBA 2401, Principles of Macroeconomics
Now, let us say that you do not have much money or your supply is low. To make
money to me when you do not have much, and there are many opportunities for
you, and since you are
rational and the supply of money is low, then you will charge me a higher interest rate. Since my demand is
there, I really need the money, and you need to forgo the use of money for your next best opportunity for its
use. On the other hand, lets assume you recently won the mega lottery and have plenty of money, so
plentiful that you are looking to invest some of it. Your supply of money is high. I, on the other hand, would
like to borrow some money; my demand is there, but since I know you have plenty of money to lend, I will not
offer you a high price since your supply exceeds my demand.
Let us consider interest rates in terms of the economy and money supply and demand. Keep in mind that
interest is the opportunity cost of money, and the rate charged will depend on the supply and demand for that
money. In other words, if the demand for money is high and the supply is held constant (demand exceeds
supply), then the price for money goes up to reach equilibrium. If the demand for money is low but the supply
is high, then interest rates will fall.
Consider the basic principles of the demand for money in the economy. As the interest rates go up, then the
opportunity cost of holding money goes up, and you are losing out because by holding money then you are
losing out on the opportunity of higher interest rate earnings, and people demand less money. On the other
hand, if interest rates fall then you likely are not as interested in the opportunity of receiving less money for
lending money, and likely will just buy your next best alternative, a car, a house, and so forth. Yes, as interest
rates rise, the demand for money decreases, and as interest rates fall, the demand for money increases, or
interest rates and demand for money are inversely related.
In the economy, as the prices for goods and services go up, then we need more money to buy the same
goods and services, and the demand for money goes up. Of course, the reverse would be true, even though
we have not seen it happen in our lifetimes. As our income level goes up (we have more money), then our
consumption increases, and the demand for money goes up as well.
Money supply is fixed by the government, or specifically by the Federal Reserve bank. Consider it a constant
when you consider the supply and demand principles.
Therefore, one can see how interest rates are determined with the above thoughts. Let us see how this
relates to our current economy. Interest rates are at a historic low, which means that due to the recent
financial crisis, the cost of money was dropped dramatically to encourage people to spend or increase
consumption. One can easily see how the government can increase the supply of money to cause interest
rates to drop. As the demand for money increases, one can likely expect the interest rates to rise in the
general economy to reach equilibrium.
Click here for the Chapter 13 Presentation in PowerPoint form. Click here to access a PDF version of the
Click here for the Chapter 14 Presentation in PowerPoint form. Click here to access a PDF version of the
Click here for the Chapter 15 Presentation in PowerPoint form. Click here to access a PDF version of the
Davies, G., & Davies, R. (2002). A comparative chronology of money. Retrieved from
Federal Reserve Bank of Cleveland. (n.d.). Economic research and data. Retrieved from
Hughes, J. P., Lang, W. W., Mester, L. J., Moon, C-G., & Pagano, M. S. (2002). Do bankers sacrifice value to
build empires? Managerial incentives, industry consolidation, and financial performance. Retrieved
BBA 2401, Principles of Macroeconomics
The Federal Reserve Board. (2011). The structure of the Federal Reserve system:
Committee. Retrieved from http://www.federalreserve.gov/pubs/frseries/frseri2.htm
Learning Activities (Non-Graded)
The following links allow one to explore banking policies in another country. Economic differences are
fascinating as one can observe differences, and one can note also how similar economic entities become
Non-graded Learning Activities are provided to aid students in their course of study. You do not have to
submit them. If you have questions, contact your instructor for further guidance and information.
BBA 2401, Principles of Macroeconomics
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