Economics: Private and Public Choice Essay Sample

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1. What determines whether a financial asset is included in the M1 money supply? Why are interest-earning checkable deposits included in M1, whereas interest-earning savings accounts and Treasury bills are not?

A financial assest is included in the M1 money supply when it can be quickly converted into the physical form of money, such as dollars and coins. Interested-earning checkable deposits are included because it can be quickly accessible without limitations, such as a checking account. Interest earning savings accounts and Treasury bills are short term investments and may have a time limit. 2. Why are banks able to maintain reserves that are only a fraction of the demand and savings deposits of their customers? Is your money safe in a bank? Why or why not?

Savings cannot always be withdrawn and are more stable than checking accounts, as a result banks need to maintain reserves against their checking accounts (Gwartney, et al. 2013). Yes, money is safe in banks because the Federal Deposit Insurance Corporation (FDIC) was established in 1934 as a result of the 1922 to 1933 bank runs. This insurance insures me up to $250,000 per account if the bank fails.

3. How would the following influence the growth rates of the M1 and M2 money supply figures over time?

a. An increase in the quantity of U.S. currency held overseas. Decrease b. A shift of funds from interest-earning checking deposits to money market mutual funds. Decrease in M1 c. A reduction in the holdings of currency by the general public because debit cards have become more popular and widely accepted. Decrease in M1 d. The shift of funds from money market mutual funds into stock and bond mutual funds because the fees to invest in the latter have declined. Increase

4. Suppose that the reserve requirement is 10 percent and the balance sheet of the People’s National Bank looks like the accompanying example.

Assets| Liabilities|
Vault Cash $20,000| Checking deposits $200,000|
Deposits at Fed $30,000| Net Worth $15,000|
Securities $45,000| |
Loans $120,000| |

a. What are the required reserves of People’s National Bank? Does the bank have any excess reserves? The required reserves is $20,000 (10% of $200,000) and excess reserves is $30,000 ($50,000 minus $20,000) b. What is the maximum loan that the bank could extend? $30,000 c. Indicate how the bank’s balance sheet would be altered if it extended this loan (show the new t-account). Assets| Liabilities|

Vault Cash $20,000| Checking deposits $200,000|
Deposits at Fed $0| Net Worth $15,000|
Securities $45,000| |
Loans $150,000| |

d. Suppose that the required reserves were 20 percent. If this were the case, would the bank be in a position to extend any additional loans? Explain. The bank would not be able to extend any additional loans because an increase in the required reserves is a decrease in excess reserves. 20% of $200,000 = $40,000 (required reserve) $50,000 (actual reserve) minus $40,000 = $10,000 excess reserves.


Gwartney, James, Richard Stroup, Russell Sobel, and David Macpherson. Economics: Private and Public Choice. Mason: South-Western Cengage, 2013.

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