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Micro Economy Essay

951 words - 4 pages

Question 1
Provide short answers to the following:
(a) Explain in detail the process whereby banks create money.
1. Banks have excess reserves
2. Banks lend excess reserves
3. The quantity of money increases.
4. New money is used to make payments.
5. Some of the new money remains on deposit.
6. Some of the new money is a currency drain
7. Desired reserves increase because deposits have increased
8. Excess reserves decrease.
(b) What factors constrain the ability of banks to create money?
There are 3 factors constrain the ability of banks to create money:
1. The monetary base
2. Desired reserves
3. Desired currency holding

Question 2
...view middle of the document...

So there is a general shortage of all kinds of goods and services. The shortage of goods and services forces the price level to rise. As the price level rise, the real quantity of money decreases. The decrease in the quantity of real money raises the nominal interest rate and the real interest rate. As the interest rate rises, spending plans are cut back, and eventually the original full-employment equilibrium is restored.
(d) How can we reconcile the existence of a nominal interest rate in the money market and a real interest rate in the loanable funds market? Explain.
When the inflation rate equals the expected inflation rate and when real GDP equals potential GDP, the money market and the loanable funs market are in long-run equilibrium. In long-run equilibrium, the Reserve Bank increases the quantity of money, eventually a new long-run equilibrium is reached in which nothing real has changed. Real GDP, employment, the real quantity of money and the real interest rate return to their original levels.

Question 3
Provide short answers to the following:
(a) What does it mean when we say that the demand for dollars is a derived demand?
People buy Australian dollars in the foreign exchange market so that they can buy Australian-produced goods and services – Australian exports.
(b) Most global trade takes place using US dollars (the dominant global currency). What advantages do you think might accrue to the United States from having the world’s dominant currency?
Since the dollar is the world's currency, other countries are more willing to buy U.S. Treasuries, which is just like buying dollars. In fact, the dollar makes up most of the world's central bank foreign currency reserves. High demand for the dollar, and Treasuries, means the U.S. government doesn't need as high a return, or yield.
(c) The Australian dollar is often described as being a “commodity...

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