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Unformatted text preview: 180.101 Principles of Macroeconomics, Fall 2011 Final Exam : Practice Problems 1. Granting your oddly specific wish, a genie magically creates a suitcase containing four hundred pennies, four quarters, five thousand $100 bills, and a check from the Fed for ten thousand dollars payable to cash. (a) How much currency did the genie give you? And how much M1? The pennies, quarters, and bills are all currency. These total to a value of $500,005. The check payable to cash is also included in M1 with the currency, so the total value of M1 in the suitcase is $510,005. (b) If you also have a debit card with a $2000 limit, a $1 million savings deposit, and a credit card with a $200 credit limit, what is your total quantity of M2? The debit card draws on a checking account, so it is part of both M1 and M2. The savings deposit is also part of M2. Credit cards are not part of the money supply. Thus the total quantity of M2 is $1,512,005. (c) If you owe $2005 to Johns Hopkins University for tuition, what is your net worth? Net worth is defined as assets less liabilities. Assuming no other assets or liabilites than the ones listed here, your net worth is $1,510,000, because the $2005 debt is a liability. (d) In a fit of generosity, you give the suitcase to your best friend, who deposits all of its contents at Bank A. If the required reserve ratio is 5%, explain how the money supply will be affected (in total). What is the deposit multiplier in this question? When the money in the suitcase is deposited at Bank A, Bank As demand deposits go up by $510,005, its reserves go up by the same amount (some in the form of cash in the vault, and some in the form of a larger reserve deposit account at the Fed from the check), but its required reserves only go up by 5% of this amount. The remaining 95% is excess reserves and able to be loaned out to households or firms, so that the bank will earn interest. When the bank loans out the excess reserves, this money will eventually make its way to another bank, which will also be able to loan out 95% of that quantity. This repeated process is called deposit expansion. The deposit multiplier here is 1 . 05 = 20, so the total change in deposits will be $10,200,100. The initial deposit took money out of circulation, so this subtracts from the money supply. The total change in the money supply is thus $9,690,095. 2. Explain the following concepts. (a) Explain what it means for a bank to be reserve deficient. What must a bank do if it finds itself in this situation? A bank is reserve deficient when its total reserves (cash on hand plus its reserve deposit account at the Fed) are less than its required reserves. Required reserves are equal to the required reserve ratio times the banks total demand deposits. If a bank is reserve deficient, it is in violation of the law and must rectify the situation very quickly. It does so by acquiring reserves however it can. This might involve selling assets or taking out a loan from a bank that has excess reserves (borrowing federal funds)....
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