Main Principles of Economics - Assignment Example

? Econ reading and short essay questions Answer Questions for Review near the top of page 641 Money is combination of assets that used as a medium of exchange in an economy while commodity money is the value that an item has even if it has not been utilized as money for example; a gold (Mankiw, 2011). On the contrary, Fiat money is the one that does not have intrinsic value. Fiat money may be utilized upon government decree. On the other hand, demand deposits are account balances in a bank that depositors may obtain via writing a check upon request. Therefore, demand deposits should be included in the stock money in order to measure the value of money in the stock (Mankiw, 2011). The U.S Federal Reserve System acts as a central bank, it sets monetary policies in an economy. The Federal group is appointed by the president upon senate approval. Fed can increase the amount money in circulation through open market operation, whereby, Fed can make dollars and utilize them to buy bonds this led to an increase the amount of money in circulation (Mankiw, 2011). On the contrary, banks do not hold 100 reserves because they lend some money to earn profits. The relationship between amount of reserves and amount of money in the banking system a rises because banks accepts deposits from the public and lend out some deposits while ensuring proportion bank reserve is maintained (Mankiw, 2011). If bank A has a leverage ratio of 10, while Bank B has a leverage ratio of 20 whereby, similar losses on bank loans at the two banks cause the value of their assets to fall by 7 percent. The above statement indicates that bank B showed a larger change in bank capital than bank A because its capital value declined twice as much as bank A. However, the two banks remained solvent because they can be able to meet their financial obligation. Connectively, discount rate is an interest rate charged by Fed to commercial banks when advancing loans, when Fed raises discount rates, the amount of money in circulation decreases (Mankiw, 2011). Discount rate is the interest rate charged by Fed to commercial bank on borrowed funds, when Fed raises the discount rates, bank reserve decrease this in turn causes the cost of borrowing to increase. This discourages borrowing and consequently reduces the amount of money in circulation (Mankiw, 2011). . On the other hand, a reserve requirement is the amount of funds that a bank should retain after advancing loans. Whereby, an increase in reserve requirement causes an increase in reserve ratio, this in turn leads to a decrease in money supply. Additionally, Fed can not perfectly control the supply money because it does not have control of the amount of money held in the pockets of households. Secondly, Fed does not have control of the amount of money advanced as loans by the banks (Mankiw, 2011). 2.) Answer Questions for Review #1 in the middle of page 666 The value of money may be affected through increasing price level. This is because the money tends to lose its value this further reduces the purchasing power of money. According to the quantity theory of money, an increase in quantity of money leads to an increase in inflation rates. In above connection, nominal variables are those measured in monetary terms while real variables are those that can be measured in physical terms. According to the principle of monetary neutrality, nominal variables may be affected by changes in quantity of money. Inflation is like a tax in the senses that when government print money, the amount of money held by people losses value due to increase in money supply (Mankiw, 2011). According to Fishers effect, an increase in inflation rate causes real interest to fall. On the hand, nominal interest rate increases. The cost of inflation may involve menu cost that causes the company to adjust its prices such cost of printing new catalogues, advertising to mention just but a few. The most important cost for the U.S economy is inflation cost because an increase the tax burden makes the government to correct more tax revenues. Connectively, if Inflation is less expected debtors are likely to benefit because they pay less than what they had borrowed in terms of value. 3.) Then answer: Are you as an individual better or worse off as a consequence of inflation? Inflation makes me as an individual worse than before because it reduces the purchasing power of money, making a lot of money to buy few good and services (Mankiw, 2011). 4.) Answer Questions for Review #1 near the middle of page 691 A net export involves a difference between total exports and total imports of a country, while net capital outflow are assets invested in foreign nations. The two are related in the senses that there is flow of fund inside and outside a country. In above connection, saving, investment and capital outflows relates in the sense that if savings exceeds domestic investment, the remaining funds may be utilize to make foreign investment this may cause a capital outflow. The nominal exchange rates are $1=80yen while on the other hand, real exchange rates are Real exchange rate = Nominal exchange rate ? Domestic price =80yens ?$10,000= $1.6 Foreign price 500,000yens Purchasing power parity asserted that different currencies must have the same purchasing power. Connectively, if Fed started printing large quantities of U.S dollars, the purchasing power of the US dollar would fall; hence more U.S dollars would be required to buy few Japanese Yen. 5.) Answer Questions for Review #2 on page 714 Demand and supply in the market for loan able funds occurs when real interest rates adjust in order to balance demand and supply for loanable funds. On the contrary, foreign currency exchange market involves adjustment of real exchange rates in order to balance demand and supply of dollars. The two markets are interlinked in the sensed that both involve net capital outflow in their operation. Connectively, budget deficit and trade deficit are some times called twin deficit because both are summaries of two economic issues that involve spending more than what economy can earn. If textile workers’ union encourages aged people to buy only American- made clothes, a favorable balance of trade would be experienced. This may further improve real exchange rates of the U.S currency. On the contrary, the market performance of textile industry would fall, while that of auto industry would improve. In above connection, capital fights involves sudden movement of cash outside the domestic country into other foreign countries. Capital flights cause an increase in interest rates and a decline in exchange rates (Mankiw, 2011). 6.) Do you think the current imbalance between our exports and imports, with imports significantly greater than exports, a good or bad condition? Having more import than export is a bad condition because it indicates unfavorable balance of trade. A country with this condition tends to consume more foreign goods than its domestic goods. This may make the country to lag behind economic development (Mankiw, 2011). References Mankiw, N. G. (2011). Principles of economics. Mason, Ohio: Thomson South-Western. Read More