ECON202answerkey3 - Malhar Nabar ECON 202 SPRING 2009...

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Malhar Nabar ECON 202 SPRING 2009 Answer Key #3 Posted: April 7, 2009 1. Money and Inflation Please consult the articles on Zimbabwe and the Berkshires from the New York Times, and on the future of cash from the Economist (available in the articles sub-conference). (a) What are the advantages to customers and merchants of the new cellphone-based payment systems over cash? Over credit cards? Customers are likely to find the new payment system more convenient than using cash, especially for small amounts. The new payment system will eliminate the nuisance of carrying small change around. Merchants are likely to find the new system more useful since it reduces theft at the till. The benefit over credit cards is that in some countries consumers find it hard to qualify for credit cards, whereas with this new system of debiting amounts from a pre-paid account, they can fill up their balance on the account ahead of the transactions. They won’t have to satisfy difficult credit-worthiness requirements to qualify for the account. From the perspective of merchants, they can get the full value of the transaction without having to pay the credit card company a commission. The merchants will most likely incur an upfront cost of installing the scanning devices, but in the long run they may find this new system more profitable than payments through credit cards. (b) According to the article from the Economist, why will cash endure as a means of payment? According to the article, cash will endure because it provides anonymity to both parties of the transaction. Much of the underground economy requires the absence of a paper trail. Illegal activities as well as transactions for which there is some tax evasion will always be conducted using cash. Another reason for the durability of cash is that some customers may not be able to purchase cellphones and some merchants may feel that the scale of their business does not warrant an upfront investment in the smart scanning devices. This subset of the economy will continue to use cash for their transactions. (c) What crucial social element does the experiment with an alternative currency in the Berkshires rely on for its success? What general principle about fiat money does this article illustrate? The experiment in the Berkshires demonstrates the need for a social convention that supports the use of paper money. Since the paper money is intrinsically useless (unlike gold or silver), the only factor that provides it with value is a social norm of accepting the paper money in transactions. Fiat money (i.e. a
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