Chapter 16 On Money

16 On Money

Chapter Sixteen

On money

Self-assessment Questions 16.1(a)

Currency in circulation possesses perfect acceptability since it is a legal tender. Demand deposits are not as acceptable as currency in circulation.

16.1(b)

Demand deposits are more convenient than currency in transactions involving large amount.

16.2

John should put the money in a time deposit account, because the interest return on time deposits is the highest.

16.3

Gold could be a better form of money than paper money. This is because

16.4

1)

gold is more durable than paper money.

2)

the supply of gold is more limited than paper money.

3)

the value of gold can be more stable than that of paper money.

Demand deposits are included in M2 because they are good stores of value. Yet, they are included in M1 because they can serve as a generally acceptable medium of exchange for settling transactions. Hence, the statement is incorrect.

16.5

M1 will not be affected. The increase in demand deposits is matched by a corresponding decrease in cash in the non-bank public. M2 will not be affected. This is because neither M1, nor savings deposits, nor time deposits, nor negotiable certificates of deposits with licensed banks is affected.

Multiple Choice Questions 1 6 10

A A A

2 7 11

A B B

2

Potatoes are divisible, so that (4) is wrong.

3

M2 will remain unchanged, because the drop in currency in public circulation is matched by a corresponding increase in time deposit. Therefore, (4) is wrong.

8

When the note-issuing banks return some Certificate of Indebtedness to the Hong Kong Monetary Authority for US dollars, they have to contract the currency supply.

9

There will be a decrease in demand deposits. With currency in public circulation, savings deposits, time deposits and NCDs issued by the licensed banks held outside the monetary sector remaining unchanged, M1 and M2 will necessarily fall.

New Introductory Economics 3rd Edition Suggested Solutions

3 8

A B

38

4 9

B D

5

B

© Pearson Education Asia Limited 2003

16 On Money

11

Bank notes are ‘inconvertible’ money in the sense that the issuing authority does not promise to redeem it for ‘gold’ or ‘silver’ on request.

Short Questions 12

This country is more likely a desert country. One of the important properties of ‘good’ money is that it is limited in supply. Shells are more limited in supply in a desert country. In an island country surrounded by the sea on all sides, shells are likely to be in plentiful supply. It is unlikely that the monetary authority can exert proper control over the supply of shells.

13

John is wrong. M3 does not equal M1 plus M2. Mary is correct. By definition, M1 is a subset of M2, and M2 is a subset of M3. Hence, M1 is a component of M3.

Structured Essay Question 14(a)(i)

Demand deposits

14(a)(ii)

Savings deposits, time deposits, and negotiable certificates of deposits issued by licensed banks held outside the monetary sector

14(b)

M1 is based on the medium of exchange function as it includes assets that serve as convenient media of exchange. M2 is based on the store of value function as it also includes assets that are good stores of value.

14(c)(i)

Demand deposits, because they enable him to withdraw his money at any time he chooses and are therefore the most liquid bank deposits.

14(c)(ii)

Time deposits, because the rate of interest on time deposits is the highest.

14(d)(i)

Note-issuing banks have to buy Certificates of Indebtedness with US dollars at a rate of HK$7.8 per US dollar from the Hong Kong Monetary Authority. Coins and new $10 notes are issued by the Hong Kong Monetary Authority.

14(d)(ii) This is because Hong Kong currency supply is 100% backed up by foreign currency.

New Introductory Economics 3rd Edition Suggested Solutions

39

© Pearson Education Asia Limited 2003