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Solutions to the End-of-Chapter Questions, Problems, and Data
Exercises
2.1 Do We Need Money?
Learning objectives: Analyze the inefficiencies of a barter system.
Review Questions
1.1 Barter is a system of exchange in which individuals trade goods and services directly for other
goods and services. The costs of a barter system include the transactions cost of searching for
1.3 Specialization is a system in which individuals produce the goods or services for which they
Problems and Applications
1.4 From the point of view of an individual, a $20 Federal Reserve Note is more convenient than a
1.5 The primary difference would be that using a deerskin as money incurs a much larger
1.7 Cigarettes must have been acceptable to most people (because so many people smoked
2.2 The Key Functions of Money
Review Questions
2.1 To serve as money, dollar bills and personal checks must generally be accepted as means of
payment. Various circumstances might cause you or a business to be reluctant to accept a
2.2 The four main functions of money are to serve as a medium of exchange (generally accepted means
2.3 No, the store-of-value function is not unique to money. Houses, bonds, and stocks are other
Problems and Applications
2.5 a. It is difficult to carry milk around, the bottles could break, and the milk can go bad if not
b. Each good could be listed in terms of the amount of milk required to exchange for the particular
d. Future milk can be promised for present goods. However, changes in the value of milk due to
2.6 a. North Korean citizens with large holdings of the old currency could only exchange a limited
2.7 a. Wealth increases
2.8. People who hold a lot of cash would gain, as well as those who wanted to be anonymous when
they buy something. Apple would lose in this situation, as they would not be able to keep track
2.9. As long as many German stores continued to accept the deutsche mark, it could serve as money.
2.3 The Payments System
Learning objective: Explain the role of the payments system in the economy.
Review Questions
3.1 A payments system is a mechanism for conducting transactions in the economy. If the payments
3.3 It is likely that more transactions in the United States will be cashless in the future, but it is
Problems and Applications
3.4 When the stones are destroyed, the value of stones increases because there are fewer of them
3.5 a. The coinage had greater amounts of less valuable metals mixed in with the gold and silver.
c. “In kind” means to pay for a service or good with another service or good. Paying in kind
3.6 Households would rely more on cash and personal checks to buy goods and services and to pay
3.7 Competitors to PayPal would need to have enough merchants and households using their
electronic payments system to make the system work and would need enough business to
2.4 Measuring the Money Supply
Learning objective: Explain how the U.S. money supply is measured.
Review Questions
4.1 The assets in M1 are more liquid. M1 is the narrow definition of the money supply and includes
currency in circulation, traveler’s checks, and checking account deposits, all assets that are
4.2 M2 has grown more rapidly. Certificates of deposit, money market mutual fund shares, and
Problems and Applications
4.3 Liquidity indicates the ease with which an asset can be converted to money. Ranking from most
4.4 a. Both M1 and M2
4.5 M1 will decrease and M2 will stay the same. M2 includes both the checking account deposit
4.6 Credit is not a form of money, because it is a debt that is owed to the issuer of the card. A
4.7 Gold has had intrinsic value for thousands of years. It meets all the requirements for money
except that it is difficult to transport. Some people do not trust fiat currency when the central
4.8 Some countries with less central bank discipline have inflation problems or currency crises.
Holding U.S. dollars is a way for households and firms to avoid the losses cause by inflation
reducing the purchasing power of the domestic currency. Also, many goods traded
4.9 This answer depends on what M1 is being used to measure. If M1 is being used to measure the
money supply in the United States, this statement is correct. If M1 is being used as a measure of
2.5 The Quantity Theory of Money: A Look First at the Link Between
Money and Prices
Learning objective: Use the quantity theory of money to analyze the relationship between money
and prices in the long run.
Review Questions
5.1 The equation of exchange relates the quantity of money, M, the velocity of money, V, the price
level, P, and the level of real GDP, Y as M × V P × Y. With the velocity of money defined as
5.2 The quantity theory of money is a theory about the relationship between money and prices that
5.3 Hyperinflation refers to a rate of inflation that exceeds 50% per month. Large increases in the
money supply cause hyperinflation. As prices rise, the purchasing power of the currency falls,
5.4 Pros: The central bank will be independent from direct political influence. For example, in the
United States, the independence of the Fed means that Congress has no direct control over
Problems and Applications
5.5 Rearranging the equation from page 37: % V (%P %Y ) % M or 1 (2 3) 4. The
5.6 This statement is not necessarily true because if velocity falls more than the money supply rises,
5.7 The money supply falling, the velocity of money falling, or the money supply increasing more
For example, if velocity is constant, while real GDP increases by 4%, then a 3% increase in the
5.8 Inflation reduces the value of money. Fewer transactions using money may occur if inflation is
5.9 a. A “commodity standard” refers to a commodity that the quantity of money is linked to. Prior to
b. The money supply, being tied to a commodity, could not grow unless the quantity or the value
5.10 Ending the hyperinflation was better news for lenders to the extent that the hyperinflation was
unanticipated and resulted in borrowers paying back their loans in money that had less
5.11 The war reparations left Germany with unrealistic debt obligations. To meet these debt
obligations, Germany printed money. Printing large amounts of money caused hyperinflation,
5.12 a. Zimbabwe abandoned its own currency, the Zimbabwean dollar, because it was experiencing
5.13 Statistical evidence shows a strong relationship between the growth rate of the money supply
5.14 Reducing Fed independence would increase the influence of Congress on monetary policy
decisions. Bernanke is referring to the political pressure that governments may bring to bear on
central banks to take actions that may not be in the best long-run interests of the economy. For
Data Exercises
D2.1 For December 31, 2012: M1 Money Stock = $2,442.5 billion, Currency Component of M1 =
D2.2 a.
Date M1 M2 M1/M2
b. M1 as a proportion of M2 decreased from December 2002 to December 2007 and then
D2.3 a. In the third quarter of 2012, nominal GDP equaled $15,811 billion, the velocity of M1 equaled
6.747, and the velocity of M2 equaled 1.572. In the third quarter of 1985, nominal GDP
equaled $4,258.3, the velocity of M1 equaled 7.142, and the velocity of M2 equaled 1.742.
D2.4 Note: In FRED, in the second line below the graph of M2, highlight “Levels” to change the
units to compound annual rate of change. Similarly, below the graph of CPI, change the units
