Chap 10 solution - CH 10 SOLUTIONS TO TEXTBOOK PROBLEMS...

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CH 10 SOLUTIONS TO TEXTBOOK PROBLEMS Quick Quizzes 1. The three functions of money are: (1) medium of exchange; (2) unit of account; and (3) store of value. Money is used as a medium of exchange because money is the item people use to purchase goods and services. Money is used as a unit of account because it is the yardstick people use to post prices and record debts. Money is used as a store of value because it is an item people use to transfer purchasing power from the present to the future. 2. Commercial banks such as the Bank of Montreal are owned by individual shareholders so their primary responsibility is to maximize the profits for these shareholders. By comparison, the Bank of Canada is owned by the government and hands over to the government any profits that are earned. 3. Banks create money when they make loans and hold a fraction of the amount of the loans in reserves, resulting in an expansion of both money and credit in the economy. If the Bank of Canada wanted to use all three of its tools to decrease the money supply, it would: (1) sell government bonds from its portfolio in the open market to reduce the number of dollars in circulation; (2) increase reserve requirements to reduce the money created by banks; and (3) increase the bank rate to discourage banks from borrowing reserves from the Bank of Canada.
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Questions for Review 1. Money is different from other assets in the economy because it is the most liquid asset available. Other assets vary widely in their liquidity. 2. Commodity money is money with intrinsic value, like gold, which can be used for purposes other than as a medium of exchange. Fiat money is money without intrinsic value; it has no value other than its use as a medium of exchange. Our economy today uses fiat money. 3. Demand deposits are balances in bank accounts that depositors can access on demand simply by writing a cheque. They should be included in the stock of money because they can be used as a medium of exchange. 4. The Bank of Canada is responsible for setting monetary policy in Canada. 5. If the Bank of Canada wants to increase the supply of money with open-market operations, it purchases Canadian government bonds from the public on the open market. The purchase increases the number of dollars in the hands of the public, thus raising the money supply. 6. Banks do not hold 100 percent reserves because it is more profitable to use the reserves to make loans, which earn interest, instead of leaving the money as reserves, which earn no interest. The amount of reserves banks hold is related to the amount of money the banking system creates through the money multiplier. The smaller the fraction of reserves banks hold, the larger the money multiplier, since each dollar of reserves is used to create more money.
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