Macroeconomics A.

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Macroeconomics.

Macroeconomics

A.

  1. False. Transfer payments made to the unemployed by the government are not part of economic output.

  2. False. Value of final goods is equal to value added at all stages of production not the sales.

  3. False. Real GDP is better than nominal GDP because it adjusts the value of output economy according to price changes.

  4. True. Low unemployment means a good economy. An economy with more employed labour tends to produce more output than one with a high unemployment.

  5. False. The rate of job separation (s) is not equal to the rate of finding a job (f).

B.

1.Money depends on trust because people expect that it will be acceptedas a medium of exchange for goods and services.

2.The amount of labour hired in the market will fall. Supply of labourwill be in excess of demand for labour. Employers will want to reducethe cost of labour by cutting down on their labour. Unemployment willincrease. Therefore the unemployment rate will rise.

3.Intermediate goods are not included in GDP because it will result todouble counting. In another words, final good’s value = sum ofvalue-added of intermediate goods. For example: wheat is used toproduce bread. To produce $500 worth of bread, we need $350 of flour,$250 of wheat and $100 of seeds. Sum of value added of intermediategoods is, seed= 100-0 = 100

Wheat=250-100= 150

Flour=350-150= 100

Bread=500-350=150

FinalValue added = 100 + 150 + 100 + 150 = $500.

4.Central bank has direct control over the bank rate. It charges apolicy rate to banks that borrow money from it. A decrease in thepolicy rate lowers the cost of borrowing money and hence commercialbanks can borrow more ultimately increasing the money supply becausethis excess money is issued as loans to the citizens and vice versa.

C.

1. There is an increase in money supply because the cost of borrowingof banks has gone down with the discount rate falling from 4.5% to 2%and the interbank lending rate falling from 6% to 1%. Banks caneasily borrow and lend money to the public.

Individualbanks have the power to create money ‘out of thin air`. They dothis by extending credit to citizens. If a client deposits $100 inbank A. The bank will only keep the required reverse and lend out therest. Assuming the required reserve ratio is 10%. Then the bank wouldkeep $10 and lend out $90 to another individual. This individualwould then place the $90 in bank B. Bank B would only keep $9 andlend out $81. As the process continues, theinitial deposit of $100expands into a maximum of $1,000i.e. ($100+$90+$81+$72.90+…=$1,000), hence credit is formed.

Assumingthe an individual deposited $100 to bank A and the required reserverate is 10%

Balancesheet of bank A

Assets

Liabilities

Cash reserve $10

Loan $90

$100

Deposit $100

$100

Nowsuppose that money borrowed from bank A is paid to individual 2 whodeposits the money in bank B. Now bank B carries out its bankingtransaction. It keeps a cash reserve of 10% of 90 and lend $81 to aborrower 3.

Assets

Liabilities

Cash reserve $9

Deposit $90

Loan $81

D

$90

$90

BankB will also issue out the loan and the process will go on and on.

Thecombined Balance sheet of Banks will be:

Banks

Assets

Liabilities

Reserves

Total Assets

Bank A

$90

$100

$10

$100

Bank B

$81

$90

$9

$100

Bank C

$ $72.9

$81

$8.1

$81

Thisprocess will continue until a maximum of $1000 is reached. A decreasein discount rate of lending by the Fed will enable banks to borrowmore money and hence issue more loans. As was the case in 2007. Thefinancial&nbspcrisis&nbspof&nbsp2007‐2009&nbspsawthe deposit multiplier fall. Banks opted to issue out the extradollars of reserves that they had stored in order to earn returns.Multiple&nbspdeposit&nbspexpansionsoccurred&nbspas&nbspthe&nbspbanking&nbspsystem&nbsprepeatedly&nbsplentextra&nbsploans&nbspuntil all&nbspexcess&nbspreserves&nbspwereused up.&nbsp

2.The credit creation theory is not a realistic model because it is notan accurate depiction of the how banks operate in a modern monetaryeconomy. It doesn’t factor in flexible exchange rates and fiateconomy. In reality banks operate by attracting credit-worthycustomers to which they can loan funds to and make profit. Theseloans are made independent of their reserve deposits.