Chapter 2
Money and the Payments System
Conceptual and Analytical Problems
1. Describe at least three ways you could pay for your morning cup of coffee. What are
the advantages and disadvantages of each? (LO2)
Money: This is the most likely to be accepted, but it means you have to replenish
Check: The least likely to be accepted, and it means you have to walk around with
Debit Card: This is very convenient, and likely to be accepted. But when the
merchant).
2. You are the owner of a small sandwich shop. A buyer may offer one of several
expensive. (LO2)
Answer: Cash is the cheapest option for the merchant; no information is required
available in the check writer’s account. If not, the merchant will likely undergo a
costly process of contacting the buyer and trying to coax the funds from the
is not instantaneous and the buyer is likely already gone when the merchant may
discover that the buyer did not have the funds available.
3. Explain how money encourages specialization, and how specialization improves
everyone’s standard of living. (LO1)
Answer: Without money, people have to barter to exchange goods and services. This
have a comparative advantage, increasing the production of society as a whole, and
improving everyone’s standard of living.
4. *Could the dollar still function as the unit of account in a totally cashless society?
(LO2)
Answer: Yes. Using dollars and cents to quote prices and record debts does not
5. Give four examples of ACH transactions you might make. (LO2)
Answer:
a. You receive your paycheck as an electronic transfer from your employer’s
b. You schedule your monthly electric bill payment to be made automatically.
from your checking account on the fourth day of each month.
6. As of July 2016, 19 European Union countries have adopted the euro, while the
(LO1)
Answer: Each country has the same unit of account, making it easier for a traveler to
7. Why might each of the following commodities not serve well as money? (LO2)
a. Tomatoes
Answer:
a. Tomatoes are perishable and thus would not serve as a store of value.
b. Bricks are heavy and bulky and will break easily. In addition, even though bricks
8. Despite the efforts of the United States Treasury and the Secret Service, someone
discovery on the economy? (LO3)
Answer: People will be unwilling to accept $100 bills as payment and will require
increased by a large enough amount.
9. You receive a check drawn on another bank and deposit it into your checking account.
another customer of your own bank? (LO2)
Answer: Funds drawn on another bank are not immediately available (i.e., “on
your account, so the funds may be available almost immediately.
10. Over a nine-year period in the 16th century, King Henry VIII reduced the silver
held both the old and new pounds, which would you use first, and why? (LO1)
Answer: King Henry needed to silver to pay for wars. The use of pounds as a means
value.
11. Under what circumstances might you expect barter to reemerge in an economy that
Answer: You might expect an economy to revert to barter when the public loses
12. You visit a tropical island that has only four goods in its economy – oranges,
a. Draw a grid showing all the prices for this economy. (You should check your
were followed?
c. Do you think the change suggested in part b is worth implementing? Why or
why not?
Answer:
a. There would be six prices in total.
Oranges Pineapples Coconuts Banana
s
Oranges
Pineapple
s
Pineapples/Orang
es
s
ts
b. There would be three prices—pineapples/oranges, coconuts/oranges and
banana/oranges.
c. In the case of this four-good economy, there is only a small gain by using
grow oranges, due to their special status, thus pushing up the prices of the other
fruits in terms of oranges.
13. Consider again the tropical island described in Problem 12. Under what
oranges as money? (LO1)
Answer: The islanders must have enough confidence in their government to accept
the government will not print too much of the money and undermine its value.
Some advantages of the paper money over commodity money in the form of oranges
only the government could print new notes, while any of the islanders might decide to
grow more oranges.
14. What factors should you take into account when considering using the following
assets as stores of value? (LO1)
a. Gold
Answer:
a. The potential for the price of gold to rise, the ability to buy and sell gold
b. The rate at which real estate is appreciating and is likely to appreciate in the
c. The potential appreciation in nominal value of the stock; the historical
d. The rate of return on the bonds – including any potential capital gain as well
When assessing an asset as a store of value, the primary things to consider are the risk
15. *Under what circumstances might money in the form of currency be the best option
as a store of value? (LO1)
Answer: If there were deflation in the economy, then paper currency would increase
attractive option as a store of value.
16. Suppose a significant fall the price of certain stocks caused the market makers in
assets? (LO3)
Answer: Faced with difficulties in borrowing money, the market makers in the stocks
assets, depressing their prices and spreading the disruption.
17. *Consider an economy that only produces and consumes two goods – food and
price movements during the year? (LO3)
Answer: Since the two price indices yield different inflation rates with preferences
remaining constant, the relative price of the two goods must have changed. In other
actually purchased. Therefore, the CPI inflation rate would be higher than the rate
calculated from the GDP deflator.
18. Assuming no interest is paid on checking accounts, what would you expect to see
(LO3)
Answer: When interest rates rise, you would expect that people would shift funds
M1 to a greater degree than growth in M2, leading to a relative increase in the M2
growth rate.
19. If money growth is related to inflation, what would you expect to happen to the
such as the euro? (LO3)
Answer: Once countries join a monetary union, they effectively share a common
expect the inflation rates of these countries to converge.
20. Why might one doubt that current new forms of digital money, such as Bitcoin, will
replace more traditional fiat currencies? (LO2)
Answer: These private digital currencies currently do not fulfill the three key
21. Is the challenge of making “time consistent” policy unique to fiat-based paper
money? (LO2)
Answer: No. Even if the value of money is linked to a commodity such as gold, the
Data Exploration
1. Find the most recent level of M2 (FRED code: M2SL) and of the U.S. population
individuals.) Do you think your answer is large? Why? (LO1)
Answer: In June 2016, the value of M2 was $12,811 billion. The total population was
addition to currency in the hands of the public. It also includes holdings by
businesses, in addition to households.
2. Reproduce Figure 2.3 from 1960 to the present, showing the percent change from a
aggregates you looked at? (LO3)
Answer: The data plot of Figure 2.3 is:
M1 is relatively volatile so it may be less reliable for indicating important underlying
trends.
3. Which usually grows faster: M1 or M2? Produce a graph showing M2 (FRED code:
Answer: The plot of the ratio M2/M1 appears below. Over the long run, M2 has
by heightened caution on the part of banks.
4. Traveler’s checks are a component of M1 and M2. Using FRED, produce a graph of
Answer: The indicated data plot is:
The use of traveler’s checks has declined since the mid-1990s. Traveler’s checks were
debit cards have reduced the demand for traveler’s checks.
5. Plot the annual inflation rate based on the percent change from a year ago of the
Answer: The indicated data plot is:
The variability of inflation in the 1960s was reasonably low in the first part of the
the long interval from the mid-1980s to the financial crisis – also were periods of
relatively low inflation variability.
* indicates more difficult problems