INDIVIDUAL ASSIGNMENT 2 – ECO121

Name: Nguyen Vu Thuc Uyen

ID: QS170072
Class: IB17C – SP23
Question:
1. What is the role of Financial system? What are the main types of financial institutions
in the U.S economy, and what is their function?
Answer:
The role of Financial system:
 Serves as a link between savers and investors
 Mechanism for exchange of goods and services
 Mechanism of transfer of resources
 Promotes process of capital formation
Financial institutions can be grouped into two different categories: financial markets and
financial intermediaries.
Financial Markets:
 Stock Market
 Bond Market
Financial Intermediaries
 Banks
 Mutual Funds
Financial markets are the institutions through which savers can directly provide funds to
borrowers.
Financial intermediaries are financial institutions through which savers can indirectly
provide funds to borrowers.
Question:
2. What role do banks play in the monetary system? How do banks “create money”?
Answer:
Bank's primary role is to take in funds—called deposits—from those with money, pool
them, and lend them to those who need funds. Banks are intermediaries between
depositors (who lend money to the bank) and borrowers (to whom the bank lends
money).
Banks "create money" by means of:
Every time banks loan funds to consumers and businesses they create new money. That
loaned money, in turn, gets deposited back into the banking system where it gets loaned
again, creating more new money.
Question:
3. a. How does the money supply affect inflation (Using classical theories to answer)?
b. How does the Federal Reserve control the money supply?
c. Give at least one specific example to illustrate the Fed control inflation by using
the Fed’s tools of monetary control. (Hint: Explain in detail by using the U.S.
inflation data and policy that the Fed has used to control inflation in the U.S.
economy).
Answer:
a. Inflation occurs when the money supply of a country grows more rapidly than the
economic output of a country.
According to the quantity theory of money, if the amount of money in an economy
doubles, all else equal, price levels will also double. This means that the consumer will
pay twice as much for the same amount of goods and services. This increase in price
levels will eventually result in a rising inflation level.
b. The Fed uses three primary tools in managing the money supply and pursuing stable
economic growth. The tools are reserve requirements, the discount rate, and open market
operations.
The Fed controls the supply of money by increasing or decreasing the monetary base:
buying or selling securities.
To increase the monetary base, the Fed buys securities from any party and pays with a
check.
The same process works for decreasing the monetary base: The Fed sells securities,
getting a check from a bank in exchange. When the check is deposited, the bank's balance
at the Fed decreases.
c. Janet Yellen (2014–2018) began her tenure by cutting back on the Fed's purchases of
Treasuries when she decided to cut purchase sum bonds In 2015, US inflation was only
0.1% while GDP growth was only 2.3% and unemployment rate was up to 5.0%. By
2017, inflation was maintained at 2.1% and GDP growth at 2.3%
Question:
4. A U.S worker takes 200 hours to produce a phone and 1 hour to produce a
sweater. A Scottish worker takes 300 hours to produce a phone and X hours to produce a
sweater. What values of X will the U.S export phones and import sweater? Explain.
Answer:
In U.S:
Opportunity Cost of producing a phone = OCphoneU.S = 200hour/1hours
= 200 sweater
Opportunity Cost of producing a sweater = OCsweaterU.S = 1hour/200hours
= 0.005 phone
In Scottish:
Opportunity Cost of producing a phone = OCphoneS = 300hour/Xhours
= 200 sweater
Opportunity Cost of producing a sweater = OC sweaterS = Xhours/300hours
Assuming X = 1,5, therefore:
OCphoneS = 300hour/1,5hours
= 200 sweater
OCsweaterS = 1,5hour/300hours
=0.005 phone
U.S. will export phones and import sweaters only if it has a comparative advantage in
phone production, while Scottish also will a comparative advantage in the production of
sweaters.
This implies that the U.S. must have a lower opportunity cost in the production of phones
than the Scottish.
This can only happen when X is less than 1,5. For example, assume X = 1, we will have:
In Scottish, when X = 1:
OCphoneS = 300hour/1hours
= 300 sweaters
OCsweaterS = 1hour/300hours
= 0.003 phone
It can be seen that at X = 1, OCphoneU.S (200 sweaters) is less than OCphoneS (300
cases of wine), while OCsweaterU.S (0.005 phone) is greater than OCsweaterS (0.003).
This implies that U.S will have comparative advantage in the export of phone when X =
1, while Scottish a comparative advantage in sweater export when X= 1 again.
Therefore, U.S will export phone and import sweater only when X is less than 1,5.

--------