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Homework 1_solution - Homework 1 E305 Money and Banking...

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Homework 1 E305: Money and Banking Spring 2010 1. Describe at least three ways you could pay for your morning cup of coffee. What are the advantages and disadvantages of each? Answer: You could use money, a check, or a debit card. Money: This is the most likely to be accepted, but it means you have to replenish your cash supply periodically. Check: The least likely to be accepted, and it means you have to walk around with your checkbook. But the funds remain in your bank account for the time it takes the check to make its way through the clearing system. Debit card: This is very convenient, and likely to be accepted. But it means immediate withdrawal of the funds from your account. (This is probably the cheapest option for the merchant). Other means of payment are accepted too. 2. Could the dollar still function as the unit of account in a totally cashless society? Explain. Answer: Yes. Using dollars and cents to quote prices and record debts does not depend on cash being used as a means of payment. Dollars and cents may still serve as the standard measurement of value even if they are not themselves exchanged. 3. Assuming no interest is paid on checking accounts, what would you expect to see happen to the relative growth rates of M1 and M2 if interest rates rose significantly? Answer: When interest rates rise, you would expect that people would shift funds from checking accounts into savings accounts, as the opportunity cost of holding funds in a non-interest bearing account has risen. Checking accounts are a component of M1 while both checking and some savings accounts are included in M2. Therefore, any shift from checking to savings accounts would depress growth in M1 to a greater degree than growth in M2, leading to a relative increase in the M2 growth rate. 4. Some economists suspect that one of the reason that economies in developing countries grow so slow is that they do not have well-developed financial markets. Does this argument make sense?
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Yes, because the absence of financial markets means that funds cannot be channeled to people who have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses that would help the economy grow rapidly. 5. Comment on the following statement: “because corporations do not actually raise any funds in secondary markets, they are less important to the economy that primary markets. This statement is false. Prices in secondary markets determine the prices that firms issuing securities receive in primary markets. In addition, secondary markets make securities more liquid and thus easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important than primary markets.
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Homework 1_solution - Homework 1 E305 Money and Banking...

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