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Econ 1452 ps2

# Econ 1452 ps2 - ECON S-1452 Summer 2010 Problem Set 2(Due...

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ECON S-1452 Summer, 2010 Problem Set 2 (Due Monday, July 12) 1. Consider two countries: North and South. In South banks hold 100% of their deposits as reserves. In North, the reserve requirement is 50%. Banks do not hold excess reserves in North or in South. No cash is held by the public in South, while in North citizens hold a total of \$500,000 in cash. Each country has \$1 million in reserves. Residents buy goods and services and do their banking only in their own country. a. What is the money supply (M1) in each country? What is the money multiplier in each country? Explain. M1 is the sum of cash held by public and checking deposits, assets that has a high liquidity. So in the country of “South” the M1 is \$1M, 100% of the deposits are hold as reserves, which mean that the deposits are \$1M as well. In North the M1 is \$2,5M since no excess reserves are hold the bank cannot give out any loans, and the money multiplier is not triggered. Therefore the sum of deposits + cash held by public is ((2xreserves \$1M)= \$2M + \$500,000 ) . The money multiplier = 1/(R+E), South’s multiplier = 1/(1.0+0) =1, as reserves ratio is 100% the money is not multiplied. North’s multiplier = 1/(0.5+0)=2, the money multiplier is 2 as the banks hold only 50% of deposits in reserves the other 50% could be returned to the market. Suppose that North and South decide to form a single country, the United States of North and South (USNS). In the new country, money supply is the sum of the money supply in North and South; the reserve requirement is 10%. Banks do not hold excess

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Econ 1452 ps2 - ECON S-1452 Summer 2010 Problem Set 2(Due...

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