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# ps8ans-1 - ECON 205 PRINCIPLES OF MACROECONOMICS FALL 2008...

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ECON 205: PRINCIPLES OF MACROECONOMICS FALL 2008 MARK MOORE PROBLEM SET 8: SOLUTIONS 1. Assume that the buried treasure is cash. The assumptions stated in the problem assume that the treasure is deposited in a bank. As a result, the money supply increases by \$120 million - \$12 million = \$108 million. We have to subtract the initial \$12 million because the value of the treasure does not constitute an addition to the money supply. Note that the \$120 million (=\$12 million/0.1) is the total increase in deposits. 2. If the reserve ratio were 25%, the total change in deposits would be \$12 million/0.25=\$48 million, so the total change in the money supply would be \$48 million -\$12 million = \$36 million. If the reserve ratio were 100%, the total change in deposits would be \$12 million, and the total change in the money supply would be zero. 3. a and c. These transactions have no effect on the overall money supply. To make this clear, suppose you withdraw \$100 from Bank A , and the concert promoter deposits your \$100 in its account at Bank A. In this case, Bank A has no change in its deposits, so nothing changes. If the concert promoter deposits the \$100 in a different bank, say Bank B, then Bank A and Bank B will have offsetting transactions. b. Sam deposits \$100 in Bank A, and the required reserve ratio is 12.5%. Initially, Bank A’s balance sheet changes as follows: Change in Assets Change in Liabilities +\$100 Reserves +\$100 Checking Deposits Change in Reserves Actual Reserves +\$100 Required Reserves +\$12.50 Excess Reserves +\$87.50 After Bank A lends out its additional excess reserves, the change in Bank A’s balance sheet looks like the following: Change in Assets Change in Liabilities +\$12.50 Reserves +\$100 Checking Deposits +\$87.50 Loans

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Change in Reserves Actual Reserves +\$12.50 Required Reserves +\$12.50 Excess Reserves +\$0 These loans are then deposited elsewhere and the money creation process continues. The total change in deposits is \$100/0.125 = \$800. The total change in the money supply is \$800 - \$100 = \$700. Remember, the initial \$100 was in cash, which is part of the money supply. 4. When funds are deposited in a bank, the bank holds only a fraction of the value of deposits in reserves. The remaining funds are used to make loans, which pay a return. (Banks also use funds that are deposited to purchase government bonds, but this practice
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ps8ans-1 - ECON 205 PRINCIPLES OF MACROECONOMICS FALL 2008...

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