Economics Chapter on Money and Finance

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Questions and Answers

What is the bond price when annual interest payment is $40 and the market interest rate is 5%?

$400

$1000

$600

$800 (correct)

Which of these assets is likely to show the greatest increase in value over time?

Corporate Bonds

Government Bonds

Blue Chip Stocks (correct)

Treasury Bills

What policy should the Federal Reserve use during a severe recession?

Expansionary Monetary Policy (correct)

Targeting the Federal Funds Rate

Raising Interest Rates

Contractionary Monetary Policy

Using the equation of exchange, what is the output level if M = 1,000, V = 5, and P = 20?

250 Signup and view all the answers

According to the Taylor Rule, what is the federal funds target rate if the target inflation rate is 2%, current inflation rate is 3%, and the economy is 3% above long-run output?

7% Signup and view all the answers

What characteristic does money NOT need to possess according to its functions?

Intrinsic value Signup and view all the answers

Which of the following is NOT included in the M1 money supply?

Savings deposits Signup and view all the answers

What is the primary role of financial institutions in the market for loanable funds?

Screen and evaluate the credit of potential borrowers Signup and view all the answers

What does liquidity refer to in financial terms?

The ability to convert an asset into cash quickly Signup and view all the answers

What happens to bond prices when interest rates rise?

Bond prices fall Signup and view all the answers

Which statement about bonds is incorrect?

Bonds come with no risks involved. Signup and view all the answers

Which statement accurately describes the risk-return relationship?

Riskier assets generally offer higher returns Signup and view all the answers

What is a key benefit of a Roth IRA?

Withdrawals are tax-free Signup and view all the answers

What determines the equilibrium interest rate in the market for loanable funds?

Supply and demand for borrowed funds Signup and view all the answers

At what minimum age can a person begin collecting Social Security benefits?

62 Signup and view all the answers

Which type of deposit is NOT classified under M2?

Large savings accounts Signup and view all the answers

The liquidity of an asset is largely influenced by which of the following?

The nature of the asset's market Signup and view all the answers

Which tool of the Federal Reserve involves buying and selling bonds to influence the money supply?

Open Market Operations Signup and view all the answers

What is the primary function of the Board of Governors of the Federal Reserve?

Providing nationwide payment systems Signup and view all the answers

What type of retirement account is tax-advantaged and sponsored by an employer?

401(k) Signup and view all the answers

Which of the following statements about compounding interest is true?

Investments grow faster due to interest on both the principal and accumulated interest Signup and view all the answers

What is the primary effect of an expansionary monetary policy on interest rates?

Interest rates decrease Signup and view all the answers

Which of the following actions represents a contractionary monetary policy?

Raising reserve requirements Signup and view all the answers

How does the Federal Reserve influence interest rates?

By adjusting reserve requirements for banks Signup and view all the answers

What is the impact of increasing the discount rate on the money supply?

Decreases the money supply Signup and view all the answers

What happens to loanable funds if the government encourages greater participation in retirement plans?

Loanable funds increase; interest rates decrease Signup and view all the answers

Which of the following describes an effect of a contractionary monetary policy on borrowing?

Discourages borrowing and spending Signup and view all the answers

If the Federal Reserve decides to sell securities in the open market, what is the likely outcome on bank reserves?

Bank reserves will decrease Signup and view all the answers

What happens when the Federal Reserve decreases the interest on reserve balances?

Encourages lending and increases money supply Signup and view all the answers

Study Notes

Money

Money is not backed by a commodity; it's accepted due to government issuance.
Money must be divisible, durable, and widely accepted by many people.
It's easy to determine the value of money.
Functions of money include a medium of exchange, a unit of account, and a store of value.
Liquidity refers to how easily something can be converted to cash. More liquid assets convert easier.

Money Supply

M1 includes currency in circulation and checkable deposits.
M2 includes M1 plus savings deposits, money market deposit accounts, and small denomination time deposits.

Market for Loanable Funds

Loanable funds are funds available for borrowing.
The real interest rate is the rate at which money is borrowed or lent.
The supply of loanable funds comes from savers.
The demand for loanable funds comes from borrowers.
Equilibrium occurs where the supply and demand curves intersect.

Financial Institutions

Their functions include evaluating the creditworthiness of borrowers, reducing information costs, providing standardized financial products, and diversifying assets to reduce risk.
They also pool funds from savers and lend to borrowers.

Bonds

Bond yield is the interest payment divided by the price of the bond.
Key terms include the maturity date (when the issuer repays principal and interest), the coupon rate (the bond's interest rate), and the face value (the amount repaid at maturity).
Bond prices are inversely related to interest rates.

Stocks

Stocks represent ownership in a company, entitling owners to share in company profits.
Stocks have a risk-return relationship: riskier assets usually offer higher returns.

Retirement Accounts

401(k)s are tax-advantaged employer-sponsored retirement plans.
Traditional IRAs allow for tax-deductible contributions; withdrawals are taxed as income.

Compounding Interest

Compounding interest is calculated on both the initial principal and accumulated interest.
This causes investments or debts to grow faster over time.

Funding comes from FICA.
It's a government program for retirement income.
Eligibility includes a minimum age (62) with possible increased payments for delayed collection (up to age 70).

Monetary Policy

The FOMC (Federal Open Market Committee) sets monetary policy direction by targeting interest rates.
The Federal Funds rate is the interest rate at which banks lend to each other overnight.

Federal Reserve

The Fed provides a nationwide payments system, distributes coins/currency, regulates banks, and serves as the U.S. Treasury's banker.
The Board of Governors has seven members appointed by the president for 14-year terms.

Federal Reserve Tools and Dynamics

Tools used to manipulate the money supply include:
- Interest on Reserve Balances (IORB)
- Discount Rate
- Open Market Operations
- Reserve Requirements

Expansionary vs. Contractionary Monetary Policy

Expansionary policies lower interest rates to increase money supply and encourage borrowing and spending.
Contractionary policies raise interest rates to decrease money supply and discourage borrowing and spending.

Key Takeaways

The Federal Reserve influences interest rates through various tools.
Increasing the money supply lowers interest rates, and vice-versa.
The goal in monetary policy is to balance economic growth with stable prices and moderate interest rates.

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Description

This quiz covers key concepts in economics related to money, the money supply, loanable funds, and financial institutions. Explore the different functions of money, the distinctions between M1 and M2, and the dynamics of the market for loanable funds. Test your knowledge and understanding of these fundamental economic principles.