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A S S I G N M E N T

W E E K 9
FELICIA IRENE - 202250351

1. Explain the influence of each of the following events on the quantity of real GDP
supplied and aggregate supply in India and use a graph to illustrate.
U.S. firms move their call handling, IT, and data functions to India
Fue prices rise
Wal-Mart and Starbucks open in India
Universities in India increase the number of engineering graduates
The money wage rate rises
The price level in India Increases

Answer
Moving call-handling, IT, and data functions to India increases short-run and
long-run aggregate supply because it increases the amount of employment at
full employment and (probably) also increases the capital stock.

The rise in fuel prices raises firms’ costs. Short-run aggregate supply decreases
and the short-run aggregate supply curve shifts leftward. Long-run aggregate
supply does not change.
When Starbucks and Wal-mart open in India, short-run and long-run aggregate
supply increase. When these stores open, employment at full employment
increases and India’s capital stock increases. Both the short-run and long-run
aggregate supply curves shift rightward
Increasing the number of engineering graduates increases India’s human capital.
Both the short run and long run aggregate supply increases
An increase in the money wage rate increases firms’ costs. Short run aggregate
supply decreases but long run aggregate supply does not change. Long-run
aggregate supply does not change because in the long run the price level rises
by the same percentage the money age rate increased, so in the long run
employment does not change
In the short run, an increase in the price level increases the quantity of real GDP
demanded. In the long run, the money wage rate rises by the same percentage
so in the long run there is no change in the quantity of real GDP supplied.
ASSIGNMENT WEEK 9

MONEY, THE PRICE


LEVEL, AND INFLATION
FELICIA IRENE
202250351

CHAPTER 25
MONEY
A means of payment A medium of exchange A unit of account is Money is a store of value in
is a method of is any object that is an agreed measure the sense that it can be held
settling a debt. generally accepted in for stating the prices and exchanged later for
When a payment exchange for goods of goods and goods and services. If
has been made, and services. Without a services. To get the money were not a store of
there is no medium of exchange, most out of your value, it could not serve as a
remaining obligation goods and services budget, you have to means of payment. Money is
between the parties must be exchanged figure out whether not alone in acting as a store
to a transaction. directly for other seeing one more of value. A house, a car, and
Money serves three goods and services— movie is worth its a work of art are other
other functions : an exchange called opportunity cost examples. The more stable
Medium of barter. Barter requires the value of a commodity or
exchange a double coincidence token, the better it can act as
Unit of account of wants, a situation a store of value and the more
Store of value that rarely occurs. useful it is as money
MONEY IN THE US TODAY
In the United States today, money consists of
Currency
Deposits at banks and other depository institutions

Currency is the notes and Deposits of individuals Two official measures of money in the
coins we use in transactions. and businesses at banks United States today are known as M1
Notes are money because the and other depository and M2. M1 consists of currency and
government declares them so institutions, such as traveler’s checks plus checking
with the words “This note is savings and loan deposits owned by individuals and
legal tender for all debts, associations, are also businesses. M1 does not include
public and private.” You can counted as money. currency held by banks, and it does not
see these words on every Deposits are money include currency and checking deposits
dollar bill. The notes and because the owners of owned by the U.S. government. M2
coins held by individuals and the deposits can use consists of M1 plus time deposits,
businesses are known as them to make savings deposits, and money market
currency in circulation. payments. mutual funds and other deposits.
DEPOSITORY
INSTITUTIONS
A depository institution A commercial bank is Thrift Institutions A money market mutual
is a financial firm that a firm that is licensed Savings and loan fund is a fund operated by a
takes deposits from to receive deposits associations, savings financial institution that sells
households and firms. and make loans. A few banks, and credit shares in the fund and holds
These deposits are very large commercial unions are thrift assets such as U.S. Treasury
components of M1 and banks offer a wide institutions. bills and short-term
M2. The deposits of range of banking Savings and commercial bills. Money
three types of financial services and have Loan Association market mutual fund shares
firms make up the extensive international Savings Bank act like bank deposits.
nation’s money. They operations. The Credit Union Shareholders can write
are largest of these banks checks on their money
Commercial banks are JPMorgan Chase, market mutual fund
Thrift institutions Bank of America, accounts, but there are
Money market Wells Fargo, and restrictions on most of these
mutual funds Citigroup accounts.
WHAT DEPOSITORY
INSTITUTIONS DO
Depository institutions provide services such as check clearing, account management, and
credit cards, all of which provide an income from service fees. But depository institutions
earn most of their income by using the funds they receive from depositors to buy securities
and make loans that earn a higher interest rate than that paid to depositors. In this activity, a
depository institution must perform a balancing act weighing return against risk. To see this
balancing act, we’ll focus on the commercial banks. A commercial bank puts the funds it
receives from depositors and other funds that it borrows into three types of assets :
Cash Assets
Securities
Loans
WHAT DEPOSITORY
INSTITUTIONS DO
Cash Assets A bank’s cash Securities A bank holds Loans A loan is an advance of
assets consist of notes and U.S. government funds for a specified period of
coins in the bank’s vault (called Treasury bills and time to businesses to finance
vault cash), a deposit account commercial bills that investment and to households
at the Federal Reserve (the earn a low but risk-free to finance the purchase of
Fed), and loans to other banks. return, and U.S. homes, cars, and other durable
The first two items, vault cash government bonds and goods. The outstanding
and deposits at the Fed, are the mortgage backed balances on credit card
bank’s reserves. Loans to other securities that earn a accounts are also bank loans.
banks earn interest and the higher but riskier Loans are a bank’s riskiest and
interest rate on these loans is return. Securities would highest-earning assets: They
called the federal funds rate be sold and converted can’t be converted into cash
and the Fed sets a target for into cash assets if a assets until they are due to be
this interest rate to influence bank ran short of repaid, and some borrowers
the economy. reserves. default and never repay
ECONOMIC BENEFITS
Depository institutions provide four benefits :
Create liquidity

PROVIDED BY Pool risk


Lower the cost of borrowing
DEPOSITORY Lower the cost of monitoring borrowers

INSTITUTIONS
Create Liquidity Pool Risk A loan Lower the Cost of Lower the Cost of
Depository institutions might not be Borrowing Imagine there Monitoring Borrowers
create liquidity by repaid—a default. If are no depository By monitoring
borrowing short and you lend to one institutions and a firm is borrowers, a lender
lending long—taking person who looking for $1 million to can encourage good
deposits and standing defaults, you lose buy a new factory. It decisions that prevent
ready to repay them on the entire amount hunts for several dozen defaults. But this
short notice or on loaned. Depository people from whom to activity is costly.
demand and making loan institutions pool borrow the funds.
commitments that run for risk. Depository institutions
terms of many years. lower the cost of this
search.
HOW FINANCIAL
DEPOSITORY INNOVATIONS
INSTITUTIONS In the pursuit of larger profit, depository institutions are
constantly seeking ways to improve their products in a
ARE REGULATED process called financial innovation.sure to risk, and
obtained funds to make more loans. The development
Depository institutions are engaged in of low-cost computing and communication brought
a risky business, and a failure, financial innovations such as credit cards and daily
especially of a large bank, would have interest deposit accounts. Financial innovation has
damaging effects on the entire brought changes in the composition of money.
financial system and the economy. To Checking deposits at thrift institutions have become an
make the risk of failure small, increasing percentage of M1 while checking deposits at
depository institutions are required to commercial banks have become a decreasing
hold levels of reserves and owners’ percentage. Savings deposits have decreased as a
capital that equal or surpass ratios laid percentage of M2, while time deposits and money
down by regulation market mutual funds have expanded.
THE FEDERAL RESERVE SYSTEM
The Federal Reserve System (usually called the Fed) is the central bank of the United States. A
central bank is a bank’s bank and a public authority that regulates a nation’s depository
institutions and conducts monetary policy, which means that it adjusts the quantity of money in
circulation and influences interest rates

The Board of The Federal Reserve The Federal Open Market Committee (FOMC)
Governors A Banks The nation is is the main policymaking organ of the Federal
seven-member divided into 12 Federal Reserve System. The FOMC consists of the
board appointed Reserve districts. Each following voting members:
by the President district has a Federal The chairman and the other six members of
of the United Reserve bank that the Board of Governors
States and provides check-clearing The president of the Federal Reserve Bank
confirmed by services to commercial of New York
the Senate banks and issues bank The presidents of the other regional Federal
governs the Fed. notes. Reserve banks (of whom, on a yearly
rotating basis, only four vote)
THE FED'S BALANCE SHEET
The Fed has two main assets : The Fed has two liabilities :
U.S. government securities Currency
Mortgage-backed securities Reserves of depository institutions
U.S. Government Mortgage-Backed Currency is the dollar Reserves of
Securities The U.S. Securities bills that we use in our Depository
government securities Traditionally, the Fed daily transactions. Institutions The Fed is
held by the Fed are held only U.S. Some currency is in the banker for the
Treasury bonds. The government securities. circulation and is a banks and the
Fed buys and sells But in recent years, component of M1, reserves that the
these bonds in the the Fed has purchased and some is in banks banks deposit at the
loanable funds large quantities of and other depository Fed are a liability of
market. The Fed does mortgagebacked institutions in their the Fed.
not buy bonds securities to increase vaults and cash
directly from the U.S. the supply of loanable machines and is vault
government. funds cash
THE FED'S POLICY TOOLS
The Fed influences the quantity of money and interest rates by adjusting the quantity of reserves
available to the banks and the reserves the banks must hold. To do this, the Fed manipulates three
tools:
Open market operations
Last resort loans
Required reserve ratio

An open market operation is the Last Resort Loans The Fed is Required Reserve
purchase or sale of securities by the the lender of last resort, which Ratio The required
Fed in the loanable funds market. means that if a bank is short of reserve ratio is the
When the Fed buys securities, it reserves, it can borrow from minimum percentage
pays for them with newly created the Fed. But the Fed sets the of deposits that
bank reserves. When the Fed sells interest rate on last resort depository institutions
securities, the Fed is paid with loans and this interest rate is are required to hold as
reserves held by banks. called the discount rate. reserves.
CREATING DEPOSITS
BY MAKING LOANS
Three factors limit the quantity of loans and deposits that the banking system can create
through transactions like Andy’s. They are
The monetary base
Desired reserves
Desired currency holding
The Monetary Base You’ve Required and Desired Reserves Desired Currency Holding The
seen that the monetary Required reserves are the proportions of money held as
base is the sum of Federal minimum reserves that a bank currency and bank deposits—the
Reserve notes, coins, and must hold, and excess reserves ratio of currency to deposits—
banks’ deposits at the Fed. are actual reserves minus depend on how households and
The size of the monetary required reserves. Desired firms choose to make payments:
base limits the total reserves are the reserves that a Whether they plan to use
quantity of money that the bank plans to hold, and currency or debit cards and
banking system can unplanned reserves are actual checks.
create. reserves minus desired reserves.
THE MONEY CREATION
PROCESS
The money creation process begins with an The sequence has the following eight
increase in the monetary base, which occurs if the steps:
Fed conducts an open market operation in which 1. Banks have unplanned reserves.
it buys securities from banks and other 2. Banks lend unplanned reserves.
institutions. The Fed pays for the securities it buys 3. The quantity of money increases.
with newly created bank reserves. When the Fed 4. New money is used to make payments.
buys securities from a bank, the bank’s reserves 5. Some of the new money remains on
increase but its deposits don’t change. So the deposit.
bank has unplanned reserves. When a bank has 6. Some of the new money is a currency
unplanned reserves, it makes loans and creates drain.
deposits. When the entire banking system has 7. Desired reserves increase because
unplanned reserves, total loans and deposits deposits have increased.
increase and the quantity of money increases. 8. Unplanned reserves decrease.
THE INFLUENCES ON
MONEY HOLDING
The Price Level The Nominal Interest Real GDP The Technological change and
The quantity of Rate A fundamental quantity of money the arrival of new financial
money measured principle of economics is that households and products influence the
in dollars is that as the opportunity firms plan to hold quantity of money held.
nominal money. cost of something depends on the Financial innovations include
The quantity of increases, people try to amount they are 1. Daily interest checking
nominal money find substitutes for it. spending. The deposits
demanded is Money is no exception. quantity of money 2. Automatic transfers
proportional to the The higher the demanded in the between checking and
price level, other opportunity cost of economy as a whole saving deposits
things remaining holding money, other depends on 3. Automatic teller machines
the same. things remaining the aggregate 4. Credit cards and debit
same, the smaller is the expenditure—real cards 5. Internet banking and
quantity of real money GDP. bill paying
demanded.
THE DEMAND SHIFTS IN THE
FOR MONEY DEMAND FOR
The demand for money is the
MONEY CURVE
relationship between the quantity A change in real GDP or financial innovation
of real money demanded and the changes the demand for money and shifts the
nominal interest rate when all other demand for money curve. A decrease in real
influences on the amount of money GDP decreases the demand for money and
that people wish to hold remain the shifts the demand for money curve leftward
same. from MD0 to MD1. An increase in real GDP
has the opposite effect: It increases the
demand for money and shifts the demand for
money curve rightward from MD0 to MD2.
MONEY MARKET
EQUILIBRIUM
Money market equilibrium occurs when the quantity of money demanded equals the quantity
of money supplied. The adjustments that occur to bring money market equilibrium are
fundamentally different in the short run and the long run.

Short-Run Equilibrium The Short-Run Effect of a Change in the Long-Run Equilibrium


The quantity of money Quantity of Money Starting from a short-run You’ve just seen how
supplied is equilibrium, if the Fed increases the the nominal interest rate
determined by the quantity of money, people find themselves is determined in the
actions of the banks holding more money than the quantity money market at the
and the Fed. As the demanded. With a surplus of money level that makes the
Fed adjusts the holding, people enter the loanable funds quantity of money
quantity of money, the market and buy bonds. The increase in demanded equal the
interest rate changes. demand for bonds raises the price of a bond quantity supplied by the
and lowers the interest rate Fed.
THE QUANTITY THEORY OF MONEY
THE QUANTITY THEORY OF MONEY

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