Review Material for Midterm 1
Economics 470/570
Fall 2011
These are review questions for the first midterm exam which will be on Thursday, October 20.
Definitions
Financial Intermediary
Indirect finance
Direct finance
Adverse selection
Moral hazard
Financial Markets
Stocks and bonds
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
Fully backed, fractionally backed, and fiat money
M1
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Currency
Lender of Last Resort
Money multiplier
Questions
Chapter 2
1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?
2. To be useful as a medium of exchange, what properties should money have?
3. Describe the evolution of money from barter to fiat money. How did paper money arise?
4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?
Chapter 3
5. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.
Chapter 4
6. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?
Chapter 11
7. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are also 100 different people who want to take out $1,000 loans. Assuming an expected default rate of 10%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets.
8. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are 10 different people who want to take out $10,000 loans. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.
9. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 10% of them will need the money for emergencies. Because of this possibility, and the dire consequences if they cannot access their money at such a time, they are unwilling to lend the money for long periods of time. Explain how financial intermediation can solve this problem of "borrowing short and lending long" and increase the efficiency of financial markets.
10. Besides pooling risk, pooling small deposits, and pooling over time, what else do financial intermediaries do to increase the efficiency of financial markets?
11. Briefly, what does the phrase “increase the efficiency of financial markets” mean?
12. What is adverse selection? Give an example of adverse selection in financial markets. How can the adverse selection problem be overcome?
13. What is moral hazard? Give an example of moral hazard in financial markets. How can the moral hazard problem be overcome?
Chapter 16
14. Describe the structure of Federal Reserve districts and Federal Reserve district banks.
15. Briefly describe the major functions of Federal Reserve district banks.
16. How do member banks differ from other banks? How did the difference change in 1980?
17. Who is on the FOMC? What does the FOMC do?
18. Describe the structure and function of the Board of Governors of the Federal Reserve System.
19. How has the power structure of the Federal Reserve System shifted over time?
20. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.
Chapter 17
21. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?
22. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.
23. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 200. Use the money multiplier to find the new value of the money supply.
24. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases.
