Money multiplier
1(a). First, explain the concept of the money multiplier. Then from the information that the narrow money supply (M1) in a hypothetical Canadian economy [with a competitive banking system in which banks produce only demand deposits] is $1750 million,and the idle excess reserves drain coefficient (e) is 3%, the desired cash reserve ratio (r) for demand deposits is 8%, and the currency/deposit ratio (c) is 30%, apply the multiplier model discussed in class or chapter 15 of the textbook to determine and calculate:
(i). The equilibrium level of the monetary base (MB);
(ii) The equilibrium level of demand [chequable] deposits (D);
(iii) The total amount of cash reserves held by banks (BCR), the amount of currency (C) held by the non-bank public;
(iv) The amount of bank loans (BL) and
( v ) The values of the deposit multiplier (dm) and the money multiplier (mm).
(vi) Use diagrams to ILLUSTRATE your answers, where necessary. (10 marks)
1(b). If the economy, however, faces a situation of inflationary pressures, and the monetary authorities implement a macroeconomic policy package (consisting of both contractionary monetary policy and contractionary fiscal policy) to respectively decrease the monetary base by 25% and increase taxes which, in turn, causes the currency/deposit ratio to increase by 25%. Other things being equal,
(i) Calculate the percentage change in the equilibrium level of the money supply after the total policy change and illustrate your answer with an appropriate diagram. (Marks)
1( c ). Now, assume that the money demand function in the above economy stays the same after the policy change.
(ii) What is the expected short-run effect of the total change in the money supply on the equilibrium interest rate of this economy? Explain carefully and illustrate with appropriate diagram(s);
(iii) What is the expected short-run effect on the equilibrium levels of income, employment, and the domestic exchange rate? Explain carefully and use diagrams to illustrate your answers, where necessary. (5 marks).
1(d). If you were an economic advisor, what policy package would you have INSTEAD recommended to deal with the macroeconomic problem stated in the above question? Explain and DEFEND your answer. (5 marks)
4(a). Imagine an economy made up of the people and commodities in the Table 1 below. Each column refers to the commodity listed at the top and each row to the person listed at the left. A positive entry indicates the number of units of the commodity that someone has and is willing to sell. A negative entry indicates the number of units of the commodity that the person wants to buy. Each of these entries refers either to the quantities supplied or demanded given a price of ten dollars per unit of each commodity. For example, Elizabeth has two bushels of potatoes to sell. She wants to buy two hours of child guidance services for her daughter.
Table 1: A hypothetical 331 economy
Potatoes Dance Lessons Child guidance
Elizabeth, the potato farmer +2 0 -2
Anthony, the dance instructor -2 +2 0
Hassan, the child psychologist 0 -2 +2
Notice that all the rows and columns add up to zero. That means we have an equilibrium price system. Each person is able to trade for what is wanted and the quantities demanded and supplied are equal at the given prices.
(i) Assume Elizabeth has twenty dollars. Construct a set of money-using trades that clears the market. . Comment on your answer.
(ii) Construct a set of barter or indirect barter transactions that clears the market. Hint: Remember that services such as dance lessons or child guidance cannot be passed through an intermediary. Comment on your answer.
(15 marks)
4(b). Suppose mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, justify whether people would be more or less likely to buy a house? Explain carefully. (5 marks)
