C48 MT 10F A - UTSC: ECM C48 Midterm FALL 2010: Solutions...

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UTSC: ECM C48 Midterm – FALL 2010: Solutions Question 1. (20 Marks) S OLUTION: A) (6 marks – 2 marks each ) 1. Medium of Exchange ( means of exchange): Without money, we would have to exchange goods and services directly through what is known as barter. Money simplifies these exchanges. 2. Unit of Account ( unit of measurement): As a unit of measurement, money allows us to compare the value of goods and services. It is both the standard for pricing goods and services and the means of buying and selling them. Money also allows us to compare costs, income, and profit across time. As such, money is the foundation of the accounting system, which allows us to plan and make economic decisions. 3. Store of Value ( means of storing purchasing power for future use): As a reserve, money allows us to accumulate savings over time and to lend those savings to someone else. It makes it much simpler for us to make contracts via promising to do something now for payment in the future. B) (4 marks) Cheque – an instrument to transfer money from one account to another between banks. Cheques allow transactions to take place without the need to carry around large amounts of currency, which is a major innovation that improved the efficiency (reduced transportation costs) of the payments system when payments made back and forth cancel each other. (2 marks) Pros Cheques can be written for any amount up to the balance in the account (or even over it with overdraft feature), making transactions for large amounts much easier and greatly reduce the loss from theft, and provide convenient receipts for purchases. (1 mark) Cons Problems with a payments system based on cheques: (i) takes time to get cheques from one place to another and may take several business days before a bank will let the account holder to use the fund from a cheque deposited; and (ii) all the paper shuffling required to process cheques is costly. (1 mark) C) (5 marks)
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Gresham's Law says "the bad money drives out the good money". What is meant by this is that the bad money literally causes the good money to no longer circulate or be accepted. [This theory can be applied to things more widely than just money or economics and finance - such as movies, parties, clothing etc]. Examples include: 1) In a commodity money system based on gold or silver - people shaving small amounts of valuable gold or silver off from coins before tendering them as a means of payment (this caused governments and people to institute minimum acceptable weights for coins to be acceptable as payment for certain face values - as a way to stop or limit this practice – but this raises transactions costs of using such coinage) - the bad money, the low weight coinage, drives the good money, gold or silver coins out of use (due to these possible ripoffs) 2) In a bimetallic commodity money system based on gold AND silver coinage - if the relative price of one of the metals were to suddenly change the government would have an incentive to buy enough of the relatively cheaper metal mint up coins and use them to buy
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C48 MT 10F A - UTSC: ECM C48 Midterm FALL 2010: Solutions...

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