Will you be emailing the results of our final exams to us?

Reserves=$52

Securities=$48

Loans=$102

Demand Deposits=$202 The monetary multiplier is 1/.25=4. 13b)The excess reserve = $12 billion. The max amount to be lent= $60 billion

Reserves=$52

Securities=$48

Loans=$112

Demand Deposits=$212.

The monetary multiplier is 1/.2=5.

Hey, also if anyone is interested in hanging out for an hour or so after the review--to go over things, then let me know.

For the review, please bring copies of question set 4. Has anyone tried the quiz of the text website. Some of these questions are quite good.

a) (With a 25 percent reserve ratio) Excess Reserves = $2 billion

Assets: Reserves - $50, Securities - $48, Loans - $102

Liabilities: Demand Deposit - $200

Monetary Multiplier: 1/.25 or 4 b) (With a 20 percent reserve ratio) Excess Reserves = $12 billion

Assets: Reserves - $40, Securities - $48, Loans - $112

Securities: Demand Deposit - $200

Monetary Multiplier: 1/.20 or 5

*The larger the reserve ration, the lesser amount a bank can loan out. The second transaction can loan more money because they need to have less in the bank for reserves.

Candace and I will also be taking the exam right after the review session on Sunday. Also, can you confirm that you recieved the last set of review questions from me, I sent them to you two weeks ago.

a. The maximum amount is $2000. Reserves=$22000, Securities=$38000, Loans=$42000. The demand deposits=$102000.

b. The supply of money is increased $2000. When money is created, both loan and demand deposits are increased by $2000.

c. Reserves=$2000, Securities=$38000, Loans=$42000, and Demand Deposits=$100000.

d. This is for the 15% reserve ratio. a. Maximum amount=$7000. Both loans and demand deposits are increased by $7000. b. Supply of money is increased by $7000. Both loans and demand deposits are increased by $7000. c. Reserves=$15000, Securities=$38000, Loans=$47000, and Demand Deposits=$100000.

P.303 #13

a. The excess reserve is $2 billion. The max amount is $8 billion. Reserves=$52, Securities=$48, Loans=$102, and Demand Deposits=$202. The monetary multiplier is 1/.25=4.

b. The excess reserve is $12 billion. The max amount is $60 billion. Reserves=$52, Securities=$48, Loans=$112, and Demand Deposits=$212. The monetary multiplier is 1/.2=5. When the reserve ratio is smaller, the lending ability of banks are greater.

question 8 page 303:

a. The maximum amount of new loans that the bank can made is $2000.

Assets(after a loan of $2000):Reserves=$22,000; Securities = $38,000; loans= $42000

Liabilities(after the loan): Demand deposits=$102,00

b. When banks lend, there are creating money, so if the bank make a loan of $2000, it will increase the money supply by $2000.

c.Assets (after checks drawn):Reserves:$20,000; Securities:$38,000; Loans:$42,000,

Liabilities (after check drawn): Demand deposits $100,000

d. If the reserve ratio is 15%. (a)The maximum amount of new loans that the bank can made is $7000.

Assets(after a loan of $7000):Reserves=$22,000; Securities = $38,000; loans= $47000

Liabilities(after the loan): Demand deposits=$107,000

(b) When banks lend, there are creating money, so if the bank make a loan of $7000, it will increase the money supply by $7000.

(c)Assets (after checks drawn):Reserves:$15,000; Securities:$38,000; Loans:$42,000,

Liabilities (after check drawn): Demand deposits $100,000

a. Excess Reserves= $2 Billion The maximum lending amt.= (1/.25 x $2 Bil) = 8 billion Reserves $50 Demand Deposits $202 Securities $48 Loans $102 The monetary multiplier is 1/.25 = 4 b. Excess Reserves= $12 Billion Maximum lending amt.= (12 x 1/.20) = 60 Billion Reserves $40 Demand Deposits $212 Securities $48 Loans $112 Monetary multiplier is 1/.2 = (5) Lending ability in the commercial banking system is higher when the FED imposes lower reserve ratios because they are requiring less money to back the banks liabilities. So, the commerical banks have more of their money at their disposal.

Linda, look at the numbers supplied by Tek, Amir and Alfonso. All have tracked the consequences correctly. Everyone should know how to analyze the effects of both a loan transaction and a check transactions.

Review my notes and read chapter 15. Let's also do questions 1 and 2 on page 325. Email me your answers for questions set 4 or bring them to the review session on Sunday.

a. The maximum amount is $2000. Reserves $ 22000, Securties $38000, Loans $42000. Demand deposits $102000.

b. The supply of money is increased by $2000. When money is created, both loan and demand deposits are increased by $2000.

c. Reserves $20000, Securties $38000, Loans $42000. Demand deposits $100000.

d.(a) The maximum amount is $7000. Reserves $22000, Securties $38000, Loans $47000. Demand deposits $107000.

d.(b) The supply of money is increased by $7000. Both loans and demand deposits are both increased by $7000.

d.(c) Reserves $15000, Securties $38000, Loans $47000. Demand deposits $100000.

a. The excess reserves is 2 billion (52-200*25%). The maximum amount is 8 billion [2*(1/.25)]. Reserves $52, Securties $ 48, Loans $102. Demand deposits $202. The monetary multiplier is 1/.25 = 4.

b.The excess reserves is 12 billon (52-200*20%). The maximum amount is 60 billion [12*(1/0.2). Reserves $52, Securties $ 48, Loans $112. Demand deposits $212. The monetary multiplier is 1/.2 = 5. The smaller of reserve ratio, the greater of lending ability of banks.

a) Excess reserves = $2 billion

Maximun amount of lending for the banking system is ; $2 billion multiplied by (1/.25)= $8 billion.

Assets(in billions): Reserves=$52, Securities=$48, Loans=$108

Liabilites/Net Worth(in billions): Demand Deposits=$208

Monetary multiplier=4

b) If r=20%, then excess reserve=$12 billion.

The maximum amount of lending for the banking system is ; $12 billion multiplied by (1/0.2)= $60 billion.

Assets(in billions): Reserves=$52, Securities=$48, Loans=$112

Liabilities/Net Worth(in billions): Demand Deposits=$212

Monetary Multiplier=5

When the reserve ratio=20%, the lending ability of the commercial banking system is greater than a reserve ratio of 25%. It is greater by 7.5 times and creates an additional $52 billion. When r=20%, the bank requires less reserves and therefore has greater excess reserves. The banking system magnifies any original excess reserves into a larger amount of newly created demand-deposit money.

Assets: Reserves=$22,000, Securities=$38,000, Loans=$42,000

Liabilites/Net Worth: Demand Deposits=$102,000

b) Money supply has increased by $2000. When a bank makes a loan, money is created and demand deposit has been created which is money. A claim given by a bank is money, as are checks drawn against a demand deposit are accepted as a medium of exchange.

c) Assets: Reserves=$20,000, Securities=$38,000, Loans=$42,000

Liabilities/Net Worth: Demand Deposits=$100,000

d) a) $7000 new loans @15%.

Assets: Reserves=$22,000, Securities=$38,000, Loans=$47,000

Liabilities: Demand Deposits=$107,000

b) Money supply has increased ny $7000 or by 7% as explained previously.

c) Assets: Reserves=$15,000, Securites=$38,000, Loans=$47,000.

Liabilities/Net Worth: Demand Deposits=$100,000.

**Shannon, your calculations of the amount to be loaned at 15% are correct, however, when you calculated the amount of demand deposits after the checks had been drawn fron the loan, you subtracted $7000 from $100,000 instead of subtracting $7000 from the actual demand deposits of $107,000 that you previusly calculated in answer(d(a)).

Excess reserves= $52-(200*25%)=$2 billions. Because the bank can only lend an amount equal to its excess reserves, we can conclude that the maximun the bank might lend is $2 billion.

If 2 billions are lent:

Assets: Reserves = $52 / Securities = $48 / Loans = $102

Liabilities and net worth: Demand Deposits = $202

the money multiplier is m=1/ reserve ratio, then in this case the money multiplier is (1/0.25)=4. Then, if m=4 and excess reserves=$2, the maximun amount of new demand-deposit money which can be created is (4*2)=$8 billions.

b. Excess reserves= 52 - (200*20%)=$12 billions. The maximun the bank can lend is $12 billions. If 12 billions are lent:

Assets: Reserves= $52 / Securities = $48 / Loans=$112

Liabilities and net worth: Demand deposits= $212

The money multiplier is (1/0.20)=5. If m=5 and excess reserves=12, then the maximun amount of new demand-deposit money that can be created is (5*12)=$60.

Comparing a and b, if the reserve ratio is lower (20%), the bank will have the ability to lend 6 times more than if it is 25%. Also, there will have 7.5 more money into circulation. (is the last statement right?)

a. The excess reserves are 2 billion. The banking system can lend up to this amount(2 billion).

After 2 billion is lent: reserves $50

securities 48

loans 102

The monetary multiplier is m=1/.25=4

b. The excess reserves are 12 billion. The banking system can lend up to this amount(12 billion.

After 12 billion is lent: reserves $40

Securities 48

loans 112

The monetary multiplier is m=1/.20=5

The bank is able to lend 6 times more money. This would put more money into circulation.

While a bank must have excess reserves to incur the new liabilites which result from making a loan, the reserves are not loaned out. Remember that banks create new demand deposits when they make loans, they do not lend reerves. There is an instnace when they use reserves, this is to purchase a government security (bond) from the Fed. Look at page 310 for an example of this transaction. See the notes below under transaction number three in my last entry in the forum.

Michelle, your question 8, page 302, answer should show that reserves do not change. Loans increase to $42,000 and demand deposits rise to $102,000. these are offsetting entries which do not disturb the balance of the t-account. I urge everyone to compare this result with Michelle's numbers.

Wilma adds something new (I think) in commenting that reserves are essential to check clearing. This is important and is shown on page 297. Banks have accounts with the Fed. These are their reserve deposit accounts. When presented with a check drawn on a bank, the Fed. debits the bank's reserves and sends the check back to the bank. Notice that this is a transaction. The bank "pays" for the check by giving up some of its reserves. If the Fed receives a check from a bank, it credits the bank's account, and debits the account of the bank against which the check is drawn. These transactions are shown in the large flow chart on page 292.

Let's do question 13 on page 303. Refer to the example that I sent to you today.

I will try tomorrow to reserve a room for the review session on May 21 and post the details here.

I am not 100% sure about the answers I put for question 8. Can you tell me if they are correct to assure that I am prepared for the final exam.

1. Banks are required to have reserves from the FED. This is so the FED can control the lending ability of the banks. This also allows the facilitation of collection and clearing of checks. 2. Reserves are assets for banks because banks can easily use this money for loans or purchases. The capital is owned by them as an asset. 3. Excess reserves is the amount of money which bank's actual reserves exceeds its required reserves. 4. To calculate excess reserve you multiply the bank's demand-deposit liabilities by the reserve ratio to obtain the required reserves. Then you subtract this figure from the actual reserves that the bank has on its asset side of the balance sheet. 5. Banks make money through lending money. The bank uses its excess reserves to lend this money.

Column 1* Assests: Reserves - $22,000. Securitites - $38,000. Loans - $42,000. Liabilities: Demand Deposits - $102,000

b) Money is being created in demand deposits when a loan is made. However, when a check is drawn on the loan, the reserves and demand deposit will each go down by $2,000 after the check is cleared.

c) Column 2* - Assests: Reserves - $20,000. Securities - $38,000. Loans - $42,000. Liabilities: Demand Deposits - $100,000.

d) (a) The maximum amount with a 15% reserve ratio the bank can loan is $7,000. Column 1* Assests: Reserves - $22,000. Securities - $38,000. Loans - $47,000. Liabilities: Demand Deposit - $107,000.

(b)$7,000 has been created in Loans and Demand Deposits; this is before a check has been cleared against the loan.

(c)Column 2* Assets: Reserves - $15,000. Securities - $38,000. Loans - $47,000. Liabilities: Demand Deposits - $93,000.

**It seems I have a little extra ($1,050) in reserves after I calculated 15% of the demand deposits after the check on the loan is cleared in column 2, is this okay? Or did I not figure out the correct amount allowed to be loaned?

2. Reserves are assets for Banks--its money they have. Reserves are liabilities for federal reserves because they will have to give that money back.

3. Excess reserves are technically the remainder of a banks Actual reserves - Required Reserves. It’s a good sum of money to invest either in lending or govt. bonds.

4.. This has been answered thouroughly already.

5. I answered this question in #3.

The first question concerns a change in the bank's investment policy. Banks can hold their assets in three main ways. They can hold reserves for liquidity and to meet the requirements of the Fed. They can invest their funds in government securities that pay a relatively low rate of interest, but are safe. Finally, they can make loans to households or businesses. The latter assets are riskier than government securities, but earn a higher rate of interest for the bank.

When a bank buys a government security assets are moved from reserves to securities. On the t-account this shows up as a minus or debit from reserves and a plus or credit to securities. The bank has chosen more earnings instead of more liqidity. This transaction is shown on page 310.

Transaction 2 is a deposit to a checking account. The bank acquires funds, an addition to reserves, and increases its liabilities to a customer. Banks count on this transaction to offset the outflow of reserves when customers write checks on their accounts or withdraw cash. See page 289- bottom.

The third transaction is a loan. Here the bank purchases a loan asset, the customer's note, by crediting the borrower's account with newly created demand deposits. We credit loans by the amount of the trnsaction and on the other side of the balance sheet demand deposits incease. Note that these entries do not disturb the equality of the two sides of the balance sheet.

The fourth transaction is the reverse of the second. The last one is a new source of funds. The bank borrows from the Fed. This shows up as an increased other liability and as an increase in reserves. This loan is called a discount window loan and the interest that the bank pays is the discount rate.

Review again the material on pages 289-293. Without a good understanding of these pages, you will have problems understanding chapter 14.

I have been sick for several days, but I will try to get your assignments corrected and back to you by the end of the week.

I have tried to call you numerous times but I have been unabel to contact you. The dat that you have posted to take the final exam causes conflict with another class that i have scheduled on that day. The Prof. of that class will not allow me to reschedule the final exam in his class so I wanted to konw if it is possible to take the exam on prehaps the Thursday of the 18th of May. Please get in contact with me regarding this matter a.s.a.p. Thank you.

assets

column 1 column 2

R 2000 2000

S 38000 38000

L 42000 42000

liabilities

column 1 column 2

102,000 100,000 are these answers correct? I don't exactly understand question 8d.

2. Reserves are assets to banks but liabilities to Federal Reserve Bank, because the reserves can be used as banking when borrowing or lending money.

3. Excess reserve is the amount above the required reserve.

4. Required Reserve - Actual Reserve= Excess Reserve 5. Excess reserves directly affect a bank's ability to lend money and make investments.

2) Prof. Garrett, I read the comments of other students, however, I do not completely understand the reasons why are reserves assets for banks, but liabilites for the Federal Reserve Bank.

3). Excess reserves is the amount by which a bank's actual reserves exceeds its required reserves.

4). To calculate excess reserve one must multiply the bank's demand-deposit liabilities by the reserve ratio to obtain the required reserves and then subtract this figure from the actual reserves that the bank has on its asset side of the balance sheet.

5) The significance of excess reserves is that it allows the commercial banks to have the ability to make loans.

Let me make a few comments. The reserves as you say are in two parts- cash on hand or vault cash and reserve deposits at the Fed. Both of these are shown as reserves on the bank balance sheet. Both are also Fed. liabilities. The reserve deposits are Fed. Liabilities just as checking account balances that you and I have are the liabiities of our banks. The vault cash is also a Fed liability because it consists of Federal Reserve notes.

Alfso's point on ATMs is correct. Banks draw down their holdings of vault cash to supply money to their ATMs. Reserves provide liquidity to banks.

From an economic standpoint the purpose of the reserve requirement which divides actual reserves into required and excess in the way you all describe, is to limit bank lending. Banks cannot make new loans without excess reserves. If they did, there would be no backing for these loans.

One point to remember is that banks do not lend out their excess reserves. A loan transaction for a bank is a purchase of a financial asset, a note signed by the borrower. This asset is paid for by crediting the borrower's account with demand deposits equal to the amount borrowed.

The Fed. controls the lending activity of banks by controlling the amount of excess reserves. Banks make the decision to whom they will lend money, but the Fed. determines the total amount of lending.

Look at the terms on page 302. You should understand all of these. Let's continue to work on question set 4, I have received a couple of these. Let's also look at key question 8 on page 303. In order to answer this question you must remember how to calculate excess reserves, and how to record on the t-account the effects of a loan transaction. Remember that when we talk about changes in money supply we mean changes in the amount of demand deposits. Demand deposits make up more than two-thirds of our money supply. If you do this question once with r=20% and once with r=15%, you will have 6 answers.

The last exam will cover chapters 13-15. Chapter 15 assumes that you know chapters 9 and 10.

2.Reserves are assets for banks because they are kept on deposit with the FRB or as vault cash. The banks can freely use that money for loans or purchases because the capitol is owned by them as an asset. However reserves are a claim against the commercial banks in the Federal Reserve Bank, and kept as a liability.

3.Excess reserves is the amount of money calculated as the actual reserve, minus the amount of money that is required to be reserved.

4.Excess reserves are calculated by multiplying the banks demand deposit liabilities by the reserve ratio to obtain the amount required to be reserved. Then you subtract that amount by your actual reserves to get your excess reserves.

5.A banks ability to make loans depends on how much money they have in excess reserves. The more money the have to loan from excess reserves, the more money the will make back.

2). If the FED concidered these reserves assets the commercial bank and the FED would both be claiming ownership. These reserves are assets for the bank until the funds are demanded by the depositor.

3). Excess reserves is the amount by which a bank's actual reserves exceeds its required reserves.

4). To calculate excess reserve: multiply the bank's demand-deposit liabilities by the reserve ratio to obtain the required reserves and then subtract this figure from the actual reserves that the bank has on its asset side of the balance sheet.

5). A bank earns money through lending money. A bank can only lend money up to the amount equal to its excess reserve.

#2.Reserves are assets to banks because they are a claim banks have against the assets of another institution. Reserves are liability to the Federal Reserve Bank becasue they are a claim against it.

#3.The amount of a bank's actual reserves exceed its required reserves is the bank's excess reserves.

#4.It is calculated by using actual reserves minus required reserves, and the answer is excess reserves.

#5.The signigicance of excess reserves; it shows the ability of a commercial bank to make loans depends on the existence of excess reserves.

1. Banks are required to have reserves because it is more secure. People who deposit their money in a commercial bank have to be sure that no matter what, they can have their money back at any time. Reserves are a sort of a security mean. Also, reserves are necessary to avoid bank panics or to protect banks from going bankrupcy.

Reserves are assets for commercial banks because they deposit their money in the federal reserve bank. It is their money, they own it, thus it's an asset for them. However reserves are a liability for the Federal reserve Bank (FRB) because they are, as the book says, "a claim against it". If it's an asset for the commercial banks, it will always be a liability for the FRB.

3. Excess reserves is the amount by which the bank's actual reserves exceed its required reserves. If the commercial banks have more reserves than it is required, then she will have excess reserves.

4. Excess Reserves = Actual reserves - Required Reserves. To calculate the required reserves, we have to know the reserve ratio given by the Fed and multiply it by the commercial bank's demand deposit liabilities. Thus to find excess reserves, we just need to substract Actual Reserves with required Reserves.

5. Excess Reserves are important for a commercial bank because its liability to create money by lending depends on the size of these excess reserves. Commercial banks can lend only an amount equal to the one of its excess reserves.

Should we answer questions about reserves here or email to you?

On the coin issue- this is an interesting example of token money with a twist. While you cannot demand the equivalent value of the commodities found in a stock of coins, you can melt the coins and retrieve the metals used in making the coins. Usually the value of these metals- cooper, nickel and zinc- will be less than the face value of the coins. However, when commidity prices rise, as they did in the 1970s, the face value may be less than market value of the metals in the coins. Since coins are made from metals and these metals have industrial uses and a market value these unusual situations cannot be avoided. The general and important point is that the face value is independent of the market value of the metals use to make coins.

As you begin reading the chapter on banking notice the difference between items on the left side- assets- and items on the right side- liabilities. Do an exercise where given the items, arranged in random order, you construct a balance sheet. Also practice entering the consequences of some representative transactions. Start with two or three items on each side and show how deposits, loans, checking account withdrawls and purchases of government securities modify the t-account. For example if a check is written for cash against an account that bank pays out money and loses reserves. Thus the t-account changes are minus the amount of the check on the liabilities side and minus the same amount from reserves. These changes maintain the balance of the t-account because you subtract the same amount from each side. Remember that the rules of the balance sheet are the rules of algebra. This transaction shows one of the functions of bank reserves--they provide cash to meet current obligations.

Let's answer five questions about reserves: 1. Why are banks required to have reserves? 2. Why are reserves assets for banks, but liabilites for the Federal Reserve Bank? 3. What are excess reserves? 4. How are excess reserves calculated? 5. What is the significance of excess reserves?

If you want to check your understanding of chapter 13, take the quiz on the textbook website.

I must agree with Wilma on the coin theory. It really is interesting how the metal used for coins is of less value of the coin itself.

If possible can you please let us know as soon as possible in reference to when the final is and if you are having a review class so I may let my other professors know and make arrangements with them. Also I would like to know if you were able to correct my mid-term exam and if you may e-mail my grade to me.

Money is always and everywhere a social convention. In other words, money is whatever people decide that it will be. People are inclined to think that gold is naturally or inherently money. This is not true. While gold has some characteristics such as hardness and maleability that are convenient, the use of gold as money is a social convention.

In fact, using gold as money has some disadvantages. It is heavy and therefore difficult to transport and can vart in purity. We have moved from commodity money to token money such as Federal Reserve notes because the transaction costs of token money are less than commodity money- even gold. Token money also has the advantage of flexibility. We don't have to wait for a new gold find somewhere to increase the supply of money. If the economy needs more money the supply of money can be increased. The growth of the economy is thus not restrained by a lack of money when you use token money. There is an interesting point in the money market mutual fund discussion between Linda and Mathilde. For financial intermediaries other than banks, the uses of funds or investments must be of the same maturity as the sources of funds or liabilities. Short-term sources of funds must be used in short-term investments. Money market mutual funds pay out when their account holders write checks. The accounts there are checkable with a few restrictions. Therefore the MMMF must invest in short-term assets in the money market. As Linda points out this is the market for assets of less than one year maturity. In fact, the average maturity of MMMF's is less than two months.

This statement is further defined by having money as a medium of exchange, a unit of account, and store velue. In the old days trading was a common form to recieve other goods and services but as time went on, people needed another form of payment besides trading goods and services and that is when money was created.

A mutual fund is a broad term meaning an investment company or trust that invests money for depositors. The term money market refers to debt instruments (bonds) that mature within one year. A money market mutual fund invests in money market instruments. These investments can be quickly converted into currency and checkable deposits without financial loss.

It permits buyers and sellers to readily compare the prices of various comodities and resources. These transactions broaden and enrich trade.

pg.285 q.3d

More money often creates an increase in consumption and a decrease in savings, therefore, this statement is correct.

pg.285 q.3d

More money often creates an increase in consumption and a decrease in savings, therefore, this statement is correct.

pg.285 q.3d

More money often creates an increase in consumption and a decrease in savings, therefore, this statement is correct.

There are 4 near monies:

1)noncheckable savings account which is an account where you can withdraw currency.

2)Money market deposit account (MMDA)are accounts that offer higher interest rates but with greater restrictions.

3)Time deposits are accounts with funds that cannot be withdrawn without advance notice. The funds become available to a depositor only at maturity.

4) The last kind of near monies is the money market mutual fund (MMMF)which is an interest-bearing accounts offered by investment companies. However I'm not sure to understand what it is. Can someone try to explain me, please?

Also,professor, i still didn't receive my grade from the midterm and I still don't know if you received my review questions...

You mentioned that you were going to email the results of our mid-term exams. I did not receive my results.

pg. 285 question 3b

Money is a medium of exchange or anything accepted in exchange for goods and services. In many culture gold, silver copper...etc. have often been used as a medium of exchange which can be considered money. In todays society, we have many forms of money other than paper money and coins. Such forms of money include credit cards and debit cards.

Inflation means prices go up and decrease in the value of a nation's currency. For example: the inflation rate in Russia is very high. The decreasing value of its currency cause prices of goods and services increase rapidly. With some amount of money, people may buy less quantity of goods than previous month, it is caused by the decreasing value of its currency. Q #3f

If government issued too many pieces of paper currency, then the value of each of these units of money would decline rapidly. People will less confident in that currency, and they may refuse to accept it as a mediumof exchange. Also, too many supply of currency will cause the inflation rate increase rapidly. It is because the loss value of its currency.

When prices go up this is called inflation in the US a "dollar" buys less because it is worth less. When the economic situation of the government is less stable and the government has a lot of debt this decreases the value of its currency.

My father lived in Germany during the post WWI inflation he spoke of people needing wheel barrels to bring their weekly pay home because of the devaluation of the German mark. These people had a lot of currency but it bought very little. The value of money is equivalent only to what it can purchase.

In countries where the government is not stable the currency "legal tender" of that nation is not stable so people are not confident in the worth of that currency and may choose not to accept it in exchange for goods and services because what it may buy one day it may not be buy the next.

What we use as money is a social convention. The social convention may have government sanction as in the case of our currency, but government sanction is not essential. The checks we write are not legal tender. Other parties to transactions do not have to accept our checks. In situations where money in traditional forms is not available, communities create alternative forms of money. The classical example of this is in prisons. Prisoners-of-war camps have in the past used some commodity such as cigarettes to mediate exchange. Why cigarettes?

To explore the nature of money and related issues, let's look at some of the study questions at the end of Chapter 13. Look at question 3, options a-e, on page 285. Under the terms and concepts on the same page focus your attention especially on the following: near-monies, transaction and asset demands, legal tender, and money maarket.

Who will venture an explanation of one of these terms or some comments on question 3?

What is money? This question has absorbed the efforts of many economists and generated considerable controversy. This is not surprising as money is one of the most complex ideas in economics. Of course, we use money daily so we have an intuitive understanding of what it is. We can all put out hands on some money. But, what do we have in our hands? One approach to answering the question is to say that money is what money does. In other words we start with the functions of money. What does money do? First, it facilitates exchange. Money enables households, businesses and other agents to buy and sell. We call this the medium of exchange function of money or transactions demand for money. The term demand indicates that later we will construct a demand for money schedule, just as we did for single goods and for total output. Some people argue that the medium of exchange function is the primary function of money because it allows a general circulation of goods overcoming the disadvantages of barter. Barter is the exchange of one good for another good- apples for oranges- without the intervention of money. Buying and selling are conflated into a single act. With the use of money, we have a single commodity that expresses the value of all other commodities. Now buying and selling can be separated in time and space. You can sell today in New York and buy tomorrow in Los Angeles. The second function of money is to serve as a unit of account. Money in this role allows us to add up or aggregate items that vary in their physical characteristics. We give an assortment of goods an economic significance by assigning each a monetary value and then summing those values. This is the work of accounting. Accountants assign values to all the assets of a business to derive the book value of the company. Some of these assets may even be intangible such as the reputation of the firm (goodwill) or the value of trademarks. Aggregation is impossible without the use of money. The third important function of money is the use of money as an asset. This is termed the store of value function or, on occasions, the asset demand for money. Assets, items of value, can be arranged on a continuum or spectrum divided into two parts. On the left we put all financial assets starting with the most liquid and as we move to the right adding less liquid assets. In the middle of the spectrum we shift to real assets, again listing them from most to least liquid. On the left side we would have such assets as money, savings accounts, Treasury bills and bonds, corporate bonds, mortgages and shares of publicly listed companies. On the right or real asset side we would have such items as inventories of goods, real estate, antiques, household goods and capital goods used by businesses. This ordered list of financial and real assets would be an inventory of our wealth. Where would money be on our wealth spectrum? It would be the most liquid kind of financial asset. Money occupies this position by definition. We understand liquidity to be how easy it is to convert any other asset into money. Money is the standard of liquidity. It is the baseline for evaluating the liquidity of all other assets. If an economic agent demands liquidity, they demand money or an asset that lies close to money on the wealth spectrum. Therefore, there is a liquidity demand for money. Moving beyond functions, we might respond to our question by looking at the concrete forms of our money. Of what does our money supply consist? The largest part is checkable deposits in banks and other similar financial intermediaries. About two-thirds of the money that we use is held as bank balances. Most large payments, not made by electronic transfer of funds, are transacted by writing a check. A review of your own payment practices should confirm this statement. Bank balances are the liabilities of banks and thus can be said to be debt. The rest of our money supply consists of bills and coins. The coins are issued by the Treasury and are thus federal government liabilities. The Federal Reserve issues our bills, actually notes. Confirm this by looking at a one-dollar bill. Since the Federal Reserve ( usually referred to as the Fed.) is a government agency our currency is a government liability or debt. As you can see, our money supply is private or public debt. Finally, we can answer the money question by referring to the Fed’s definitions of the money supply. This is the M1, M2, M3 and so on approach. The “Ms” are alternative definitions of money. M1 the most narrow of the definitions includes only categories of wealth that can be used make transactions, things you can spend. M2, a broader measure, includes items you might routinely convert into transaction balances. M3 and higher numbers include assets that you might, but would not normally, convert into transactions balances. As you can see, the issue is whether an asset is a part of your wealth that you are likely to spend. If it is not it is relegated to a higher “M” category. Each of the approaches to the money question is useful in a particular context. The discussions of commercial banking, monetary theory and monetary policy all draw on our understanding of what is money.

Answering your question about the multipliers. First I calculated the savings, S=income-consumption, and then I calculated the MPS, which is MPS=the change in savings/change in income. The multiplier= 1/MPS. I think this is correct.

I believe Professor Garrett answered your question about Part VI and yes I got 1000 as the new equilibrium level of income in Part V

I have finished grading your exams and they were gernerally quite good. The median grade was 82. I will email your grades to you tomorrow.

ON the last question on the review question 3 sheet, follow Linda's suggestion. Multiply the change in sales by the capital output ratio to get net investment. Or, if required investment (sales times the capital output ratio) is less than actual capital, then this difference is equal to net investment.

Let's move on to chapters 13 and 14. Consider these as a single unit and read carefully the notes on banking below.

Banks are financial intermediaries. In this role they collect funds from households and business that have excess funds. Then they make loans to households and businesses that need to borrow funds. All financial intermediaries engage in this business. Typically they profit by charging an interest rate on loans that is higher than the cost of funds obtained from other households and businesses.

To analyze how bands work we focus our attention on the bank’s balance sheet. The balance sheet is a statement of assets and liabilities. Assets are items that you own or items that other entities owe you. Liabilities are items that you owe to another entity. Since banks acquire finds from depositors, deposits are listed on the liabilities side. Banks make loans acquiring notes payable or IOUs from households or business that borrowing funds from the bank. A first stage account or abbreviated balance sheet might be the following.

Assets Liabilities Cash reserve $150 Demand deposits $50 Plant and equipment $50 Owners equity $150

The liabilities are sources of money. The bank received funds from shareholders giving them stock in exchange and from depositors giving them checking account balances in exchange. Funds were used to create reserves and to build and furnish bank facilities.

With this balance sheet the bank would be making no profits on investments. It is not realizing this potential despite having excess reserve assets. Let’s say that the bank is required to maintain reserves equal to %20 of demand deposits. Note that the reserve is a percentage of demand deposits. The bank has three times as many reserves as deposits but must have only %20. Actual reserves are $150, but required reserves are only $10 (20% of $50 of demand deposits).

The bank can increase its income two ways related to the excess reserves. First the bank can purchase a government security (bond). If this investment is made the bank loses reserves in the amount of the bond purchase. Noting just the changes they would be:

Assets Liabilities reserve assets -$50 gov. securities +$50

There would be no other changes in the balance sheet. If the bank then decided to make a loan, it would first have to see if excess reserves existed. Required reserves are still $10 since there has been no increase in deposit liabilities. Actual reserves are now $100, so excess reserves are $90.

When a bank makes a loan it does not directly use excess reserves. The reserve remains as backing for the loan, but are not loaned out or used. To purchase the loan asset, the note or IOU given by the borrower, the bank gives newly created demand deposits. The bank and the borrower exchange liabilities. The bank keeps the borrower’s IOU, but the borrower uses the bank’s liabilities to make purchases. Most of our money consists of these bank liabilities. We call them checking account balances. When banks make loans they do not give up their reserves, instead they create money to purchase loan assets- customer IOUs.

Listing again only the changes in the balance sheet, we have: Assets Liabilities Loans + $90 Demand deposits +$90

By making a loan the bank has created money. This is the origin of most of our money.

I read your answer about part VI but I still don't get it. Do you know how we can find the required capital and actual capital because I looked all over the book and I found nothing on it. If you know what page I could look at, could please tell me? And also, for the new equilibrium level of income in part V, did you find 1000?

I believe that you do not use the table from IV to answer V. I think if you go back and read the notes sent to us on March 23,(Nation~1.htm) it may help you with this. I did it and came up with answers whether they are correct is yet another question.

In a very simple form the accelerator principle assumes that the ratio of capital to output tends to remain constant. Suppose, for example, that normally it takes $1000 worth of equipment to manufacture $1000 worth of shoes each year. Suppose further that each year one tenth of the equipment wears out. If there is no growth or decline, total investment each year will be $100, all for replacement. Now suppose that the sales of shoes jumps by 5%, to $1050 each year. The new desired amount of equipment will also rise by 5%, to $1050. However, to obtain this new level, investment will have to increase by 50%, to $150. Thus if firms desire a constant capital-to-output ratio, a small percentage change (either an increase or decrease) in final sales can lead to a big percentage change in investment.

....Good Luck....

Wilma says that according to the cicular flow, investment spending will trigger more production, causing an increase in household income. However, I was thinking that an increase in a households income would directly effect spending and then effect production.

1. (c)is constant and equals the MPC. 2. (a) equilibrium GDP is possible. 3. (d) planned C+Ig less that real GDP. 4. (c) planned C+Ig exceeds real GDP.

The consumption function and the aggregate spending curve are parallel, i.e. the distance between them is constant because investment is constant. This means, not that investment doesn't change, but that it doesn't change with income.

I see that the 45-degree line is still a problem. Mathmatically it is simply all points of equality between income and expenditure. It divides into two equal parts the space whose dimensions are income, measured horizontally, and expenditure, measured vertically. When finding equilibrium income, however, we interpret it in terms of the income/output axis--the horizontal axis. Measure spending vertically and ask yourself whether income associated with any income level is more, less or exactly equal to that spending level. The equilibrium or stable income level gives rise to a spending level equal to itself.

The review session is Saturday at 12:00. The room is posted below.

Let's discuss this question. Why does an increase in investment spending lead to an even larger increase in income. Also confirm that this is the case by assuming the investment increases to $40 in the table on page 208.

Another thing, you said that it was possible to take the exam at 7:00? I want to make sure it's right because I have a class from 5:50 to 7:10.

1.Constant and equals the MPC 2.Equilibrium GDP is possible. 3.Consumption exceeds investment. 4.Planned C+Ig exceeds real GDP.

How does this graph correspond to the tables used to find equilibrium income? In the graph above from the website (http://www,mhhe.com/economics/mcconnell) associated with the text, the 45-degree line is crossed by two lines. The lower of the two is the consumption function while the top line is aggregate expenditure or C + I. The 45-degree line itself represents the cost of producing and is equivalent to income/output or the first column in the tables that we have been working with. The income level 470 on the 45-degree line generates total expenditure equal to 470 and is thus the equilibrium level. Here businesses get back the amount that they laid out to produce goods and services. Total spending at the equilbrium is divided into 450 of consumption and the given level of investment = 20. At all other income levels on the 45-degree line, aggregate spending is either greater than income (income levels below 470) or less than income (income levels above 470). Inspect the graph to verify these relationships. Let's review again the relationship between the tables and this graph. The 45-degree line is the equivalent of the first column. The values for income/output are measured on the horizontal axis labeled real output. Income and output are alternative ways of looking at production. The C line is the consumption function or the second column in the table. Investment, the third column is not shown on the graph, but is the distance between the C line and the AE or aggregate spending line. Notice that this distance does not change with income. Finally, the top line, aggregate expenditure, is the sum of consumption and investment. In this context investment is planned spending on expansion of productive capacity and does not include unplanned investment in inventories. .

The review session is Saturday at 12:00 PM. I have reserved room 559 in Nugent, but if there is a problem with that room, we will be in room 610 Main. Bring your completed quizzes and other work with you and write down any questions that you have.

On the quiz questions, when you see "real GDP" this is income/output or the value of production. Remember that the value of production is the amount that businesses pay to produce output in the aggregate. Aggregate expenditure is what they get back. Therefore real GDP is the same thing as costs, while expenditure is revenue. If revenue exceeds costs, this is a signal to produce more. If revenue falls short of costs, this is a signal to produce less.

You should be going on the chapter 10 which is about what happens when some part of total spending increases. Look at the impact on output of an increase in investment as shown in the graphs on page 200 and the table on page 201.

Wilma, can you see the 45-degree line as showing all possible levels of costs that the business sector might incur. It is the value of all possible levels of supply, whereas the aggregate expenditure line shows the various levels of demand which arise out of production through consumption spending and a given level of investment.

Demand is not always equal to supply because only one part of demand, consumption, is derived from supply. The other part, investment, is independent of supply decisions. It is determined by interest rates and the other factors discussed here last week.

1.c.is constant and equals the MPC. 2.a. equilibrium GDP is possible. 3.d. planned C+Ig is less than real GDP. 4.c. planned C+Ig exceeds real GDP.

Prof. Garrett, I am also not sure of the 45 degree angle line. Please explain it.

1. c) is constant and equals the MPC.

2. a) equilibrium GDP is possible.

3. d) planned C + Ig is less than real GDP.

4. c) planned C + Ig exceeds real GDP.

I also only received the text part of the last email. The graph did not download correctly. I went to www.mhhe.com/economics/mcconnell but I was unable to find the graph.

1)c:is constant and equal the MPC/2)a:equilibrium GDP is possible???Like others I don't understand what exactly is the 45 degree line. Could you explain it more?.3)d:planned C+Ig is less than real GDP. 4)c:planned C+Ig is less than real GDP

1)c 2) Although the answer is said to be A, I really don't understand why. 3)d 4)c

Quiz P.191 Is the line always be 45 degree.

Re: Quick Quiz pg.191

I'm confused about the 45 degree line. Where do we get this line and why?

1) c - is constant and equals to MPC. 2) a - equilibrium GDP is possible. 3) d - planned C + Ig is less than real GDP. 4) c - planned C + Ig is less than real GDP.

Review Questions 3, Part I -

1) The level of consumer spending for the following incomes are... 100:90 , 200:140 ,and 300:190. The level of saving for the following levels of income are... 100:10 , 200:60 ,and 300:110.

Pg. 196 Q3 - The average propensity to consume (APC) is the percentage of any total income which is consumed, while the marginal propensity to consume (MPC) is the proportion of any change in income consumed. By combining the MPC and the MPS, you recieve the total income, which will be equal to one. Because you use fractions or precentages in terms of MPC and MPS, say a households MPC for a year is 85% and their MPS is 15%, together they make the total income of 100%, or 1. The basic determinants of consumption and savings schedules are wealth, expectations, household debt and determination. In terms of wealth, the savings schedule usually goes downward and the consumption schedule goes upward, because there is more money to spend. In terms of expectations, households will determine the amount of money they will spend and save in accordance to what they foresee in the future of the market. If a household has debt, most likely they will try to save some of their money to pay it off and decrease their consumption. Finally taxation effects consumption and savings, if taxation is low, then consumption and savings schedules shift upwards. Reversely if taxation is high, then consumption and savings schedules will shift downwards.

Yet, there may be a good deal of truth in what she says, but from a different point of view. Because some of current houshold spending is tied to rising stock prices- the wealth effect- (page 179 in the text) a fall in prices might depress spending. Anticipating this businesses would, no doubt, cut back on investment plans anticipating less profits on the various projects open to them.

Is there anyone out there? Am I the only one who didn't go to some tropical island?

I do not understand how I can recieve all of the notes that you e-mail to me but I can ont recive an email of the responses to my questions. You may also e-mail me information at: msrodriguez@ny.freei.net. You can also give me a call at your earliest convience.

I will reserve a room for the exam to be held at 5:50. If some people want to take the exam at 7:00, we could do that in the Business Management office at 7:15.

Amir's comment is correct. Think of the sequence of leakages in this way. First, taxes are paid, in fact, taken out of your salary before you receive it. Then income is split between saving and consumption spending. Finally, some of income spent goes to buy goods or services produced in other countries (imports). Because tax payments come first, both saving and consumption are depressed by a rise in taxes.

On the issue of inventory changes. Think of the economy as a store with an inventory of goods ready for sale. Goods come in the back door and go out the front door. There has to be a balance between the two. If too many goods are ordered- back door- relative to sales- front door, orders must be reduced. Production in the economy is equivalent to orders while aggregate spending is sales. If there is too much production relative to spending, inventories will pile up and production will be cut. Only if spending is equal production will inventories be stable and production maintained.

When the investment curve shifts to the right, (invesment increases) More investment spending will occur than before at every interest rate. This says nothing about what the interest rate is or what determines it. Actually we will learn more about that in chapter 15.

Emily raises a different question. She asks if interest rates fall will this not discourage investment. Yes, if you mean people or institutions buying financial assets such as corporate bonds. For them interest rates measure the reward they receive. However, in our disucussion of national income theory, investment means business purchases of capital goods. For them interest rates are the cost of investment; it is not a reward. The reward is the expected profit on the investment project. Whenever you read investment in chapter 9 or 10, read it as investment in capital goods or, speaking more broadly, as spending to increase the capacity to produce goods or services.

Do the quick quiz on page 191 and let's discuss these answers. If there as a questions that is not obvious raise a question about it in this space.

If the investment demand curve is increasing, then the interest rate will increase as well. Therefore, the interest rate and the investment demand curve move in conjunction.

Is this correct?

Aleida, I continue to get email sent to you returned with the message that AOL is not accepting messages to this address. Do you have an answer to this problem? Another email account?

Let's expand in a small way the table that I sent to you last week. Subtract aggregate expenditure ( this is the value of sales for all businesses) from the first column which is income/output. The difference is the change in inventories or goods available for sale. If the difference is positive, then inventories increase and if it is negative, inventories have decreased.

Rising inventories mean too much has been produced and firms cut back. Falling inventories mean too little has been produced and firms produce less. Make the calculations and let me know if the conclusions are clear.

Actual investment- see the long table in the text-is planned investment plus the change in inventories. Changes in inventories are considered investment by firms. Firms invest in capital goods to increase capacity and in goods ready for sale.

Michele, changes in interest rates alter investment by a movement along the investment demand curve. Other events such as an expectation of a recession alter investment through a shift in the curve. In the latter case, investment is more or less without any change in the interest rate.

There are a lot of factors which can shift the investment demand curve simply because business confidence in the future can be altered by many events. These include economic events like a rise in inflation, but also political events and changes in technology.

Linda is looking at the problem of interest rate change correctly. All projects have an expected rate of return. A project is justified if its expected rate of return is greater than the interest rate. This is simple cost/benefit analysis. The benefits (expected rate of return) must exceed the cost (the interest rate, i.e., the cost of funds to execute the project).

Wilma, in your response on the impact of a tax change, how are you considering income? If you are considering disposable income, that is, after tax income, the curve does not change because taxes come out first. However your answer is correct for income before taxes. This question is useful for pointing out that there are more leakages from income that just savings. Households may pay taxes and they may also spend income on imported products. The latter boosts output and employment in other countries, but not in the American economy.

I forgot the p notation last time.

I am sending by e-mail some tables and notes on equilibrium income. My notes may help you understand better the tables and graphs in chapter.

I am considering having a review session at the college on April 8 followed by the exam on the April 10. If you would be willing to come on the 8th let me know by e-mail.

Raise any questions that you have on chapter 9 in this space. If you have a question, be assured that others do also.

We have some good responses on marginal and average propensities to consume and on other determinants of consumption spending. Just as the supply and demand curves can shift as a result of changes in secondary factors, so can the consumption function. There has been much discussion of the wealth effect. When stock prices rise, stock owners feel rich and they spend more without any change in income. For example, if C=20 + .9Y before the increase, it becomes C=30 + .9Y after the rise in stock prices. In the before situation at Y=300, consumption would have been 290. After stock prices rise, the WEALTH EFFECT, consumption spending for Y=300 would be 300. In other words with high stock prices, there is no saving and the economy grows rapidly. This describes the current situation in the U.S. very well.

Let's consider an alternative case. Suppose households become fearful of the future. They therefore become more thrifty. Instead of C= 20+ .9Y, the original case, the ocnsumption function becomes C= 10 + .9Y. Then consumption spending associated with an income of 300 would be only, 280. With more saving the economy would grow more slowly. This describes well what has happened in Japan during the last few years.

Please continue to send me your answers to the review questions to me via email. Post answers to other questions here. Lets look at question 4 on page 197 in the text. Answer one of these and post the answer here.

2a) C=10+ .8(100)= 90 2b) S= 10 C=10 + .8(250)= 210 S= 40 C=10 +.8(300)= 250 S= 50 2c) The equilibrium income is 250.

The sum of MPC and MPS must be equal to one because the fraction of any change in income not consumed is considered saved income. Therefore, money saved and money consumed must equal to the entire income.

The basic determinants of the consumption and saving schedules are wealth, expectations, indebtedness and taxation. Wealth is a determinant because those who have more assets tend to spend more and save less and vice versa. Expectations of rising prices and product shortage often cause more spending and a change in the consumption and saving schedule. The Third determinant states that when there is an increase in debt there is also an increase in consumption. Whereas, in taxation an increase in taxes will shift the schedule downward.

My basic determinants are wealth and expectations. Being a student and part time worker, I must limit my consumptions, therefore, increasing my savings.

APC (average propensity to consume) is the percentage of any total income which is consumed. However, MPC(marginal propensity to consume)is the proportion of any change in income consumed. Thus, the difference between the 2 is that MPC include (calculate) the change in consumption and income whereas APC don't.

The sum of MPC and MPS must be equal to 1 because by definition the fraction of any change in income not consumed is saved. Then MPC (fraction consumed) plus MPS (fraction saved) must include the whole change in income, so it must be equal to 1.

Like Linda wrote, I think the basic determinant of the saving and consumption schedules is the level of disposable income.

Also, i know we have to do the first question of Review Questions 3 but do we have to send it by e-mail or answer to it in the forum??

The APC, on the other hand, is the ratio of total consumption spending to income. Since we assume that some spending does not depend on income--you don't stop spending altogether when you lose your job-- the APC will be different at different levels of income. Let's look at an example. Suppose C= 10 + .8Y describes the relationship between income and consumption. The 10 is constant- does not change with income. The second part- .8Y tells us that any increase in income will lead to .8 times that increase in additional spending. Now here is the punch line. The $10 of non-income dependent consumption will have a different weight in the APC calculation depending of the level of income. For example if y or income is only 10, the income-independent part of consumption is more than half of total comsumption which is only 18. At y equal to 10, consumption is 18 and APC is 18/10. But at Y=100, APC is 88/100. APC changes as income changes.

Let me stress that APC is not an ideas which is important as we go forward in the course. We simply want to understand it in order to clarify the meaning of MPC which is the change in comsumption associated with a change in income. How much additional spending do we expect from each additional dollar of income? This is a very important idea.

Prof. Garrett, can you explain to me why the sum of the MPC and the MPS equal 1.

I believe that Linda was talking about the price that the computer was sold at. Which does not affect the 1999 GDP.

Candace's point of not worrying about the price that the computer is sold at in 1999, is correct. The GDP only counts production costs, and since the computer was manufactured in 1998 it is only counted in 1998.

Professor Garrett, can you please help Amir, Linda, Candace, and I sort this out.

Let me limit somewhat the material you are responsible for in Chap. 8. You should know the stages of the business cycle, the types of unemployment and the consequences of inflation. You will not be responsible for the material on the causes of inflation- we will deal with that later- or the natural rate of unemployment- this is a discredited idea about which there is little discussion.

On the consequences of inflation note that the key element is debt. Rising prices and wages- they tend to move together- decrease the burden of debt because the debtor is paying back the debt in money of steadily decreasing value. Think of a student who borrows money for college tuition. What may be a significant payment in the beginning may be much more tolerable later as prices and wages rise.

On the other hand, inflation is damaging to lenders because, with rising prices, the purchasing power of the money that they get back is steadily less.

Even debtors, especially businesses, may be harmed by inflation if the rate of inflation is so high as to disrupt the economy.

When you begin reading chap. 9, take the material in segments. Focus on the discussion of the income, consumption and saving relationship pp. 175-181. Think of saving as not consuming. Do the first question of the the third review set and also look at question 3 on page 196. Let's have some discussion of this question in this space.

Would it be possible for you to tell us what the format of the exam on April 5th will be?

1959=$2205.22(inflating nominal GDP). 1964=$2695.12(inflating). 1967=$3133.83(inflating). 1973=$3905.65(inflating). 1988=$5864.81(inflating). 1995=$6739.70(deflating nominal GDP.

Professor, is this the correct way to explain?

1959 Real GDP=$2205.22,(inflating nominal GDP). 1964 Real GDP=$2695.12,(inflating nominal GDP). 1967 Real GDP=$3133.83,(inflating nominal GDP). 1973 Real GDP=$3905.65,(inflating nominal GDP). 1988 Real GDP=$5864.81,(inflating nominal GDP). 1995 Real GDP=$6739.70,(deflating nominal GDP).

Question #5: At the beginning of a certain year, companies have a certain amount of inventories. At the end of the same year, they usually have either more inventories, or less inventories. If they have an increase in invetories, it means that they have produced more than they have sold. On the contrary, if companies have a decline in inventories, it means that they sold more than they have produced. Because GDP measures total current output, we must include within it any products produced this year even thought they are not sold. Also, because investment is the construction or production of new capital assets, the changes in invetories discussed above are included in the GDP as part of investment spending. If inventories declined by $1 billion during 1999, it means that he have sold more than produced. However, I don't know how we know that the inventory of the year 1999 really went down. Don't we have to know the inventory of the beginning of 1999 to know how much we produced in previous year and in 1999. Maybe the inventories declined because we sold most f the products produced in 1998??? I'm sorry but I'm confused. I tried to understand the explanation of the book in 128 and 129 but I still don't understand. Can anyone help me to understand?

Question #12:real GDP(in billions):1959: $2205.2/1964: $2695.12/1967: $3133.83/ 1973:$3905.64/ 1988: $5864.8 / For all these years, we have inflated the nominal GDP. However for 1995, the real GDP is $6739.7 billions, we have have deflated it.

#12. Real GDP (billions) 1959-$2205.2, 1964-$2695.1, 1967-$3133.8, 1973-$3905.6, 1988-$5864.8, 1995-$6739.7

Candace Barbato's example is really good and helped me to understand the relationship clearly.

The questions that everyone should submit by Wed. are the second set listed on the bottom of the syllabus. Click, download, answer and email me the answers.

We have a difference of opinion on social security payments. These are a part of personal income, but are not a part of GDP. They are not a payment for services rendered to a producing unit. They are termed a transfer payment because they are a transfer of purchasing power from the working to the retired generation.

Let's move on to two last issues in chapter 7. Look at questions 5 and 12. In question 5, we are asked why a change in inventories affects GDP. Who can help us with this one?

Question 12 asks us to deflate a series of nominal GDP numbers. The arithmetic of this is simple--we divide nominal GDP by the index number which shows how much prices have increased. But, what are we doing? We are removing the consequences of higher prices on the value of output. In other words, we are taking out the increases in the Ps leaving only the increases in the Qs. ( Recall the PxQ approach.) Deflating then means taking out the inflation. Note that whenever you divide A by a number (B) greater than one you reduce A. As in 8/2=4.

When we deflate and reach our goal of showing only the quantitative increase, do we have a better measure of GDP? In some ways, yes. With inflation included we could be overstating real economic growth, especially with high inflation. However,is the growth of the economy only increases in quantity? What about price increases which reflect product improvements, not simply higher prices. If we take these price increases out, we understate the growth of the economy. The most accurate figure is probably somewhere in the middle, but this figure is not calculated.

The insurance policy did not exist before it was purchased therefore it is a new issue. But, I believe since the policy is probably for longer then 1 year its cost would need to be adjusted for the length of the policy. As in accounting for a business would this be concidered a prepaid expense and adjusted in this manner?

Wilma'a comment is correct since we can add up sources of income as well as spending streams. If we viewed this payment from the side of the renter it would be personal consumption spending. One interesting point here is that if the building were sold, the sale price would not be included in GDP. Payment for the services of the building are however a part of the currently produced services aupplied to consumers.

Do not be too concerned with the secondary measures such as Net National Product and National Income. These are rarely mentioned except in specialized discussions. Stick to the major points- the meaning of GDP, the distinction between real and nominal GDP, and the two ways to measure GDP.

Remember to submit your answers for the second group of questions to me by next week. Also logon and participate. One person in the class has already failed the course due to lack of participation and failure to submit assignments.

This is determined through the expenditure approach, that states that you add up all spending on final goods and services. Personal consumption expenditure includes consumer expeditures for services, therefore the service of a painter is included in this year's GDP.

I was wondering if you received the answers to the questions I e-mailed to you on the 19th of February. Please let me know if you haven't so I may resubmit them to you.

I will not accept any submissions of the first assignment after tomorrow. If you do not have it to me by then you fail this assignment.

The next set of questions should be sent to me by Wednesday, March 8. I have a date and room for the first exam but this information is in my office. I will post it tomorrow.

Read all of Chapter 7, but focus on three questions. How do we calculate GDP-two methods? What is the difference between real and nominal GDP? And, what goes into GDP and what is excluded?

1) Limiting price increase might be appropriate under special circumstances like after a natural disaster or during a war. For example, after earthquakes, that are still very common these days, people are generally without resources or most of them. Thus, they can't afford to buy products at a high price because they have to pay for what they lost during the disaster and even with humanitary help, it's very hard to rebuild a home (for example). During a war it's different but still the government could control prices of first necessary goods (food) because there is a lack of them or a restriction in imports or transportation.

2)A good example of a market where the price is so high that many people can't afford them, is luxury products. Luxury products are made with high quality materials, produced in restricted numbers, and could justify a higher price. That may not be fair for all consumers but if luxury goods were at a smaller price, would it be still called "luxury"? Some people could buy a Royce Rolls, some couldn't. Some of us could live on 5th Avenue, some couldn't... This question on price could be related with the question of differences in incomes.

Also, in your reply to my review questions, you stated in the end to write questions of my own. Did you refer to the D, I, IND, NC questions?, and did you want me to post them in the classroom?

I know some of the rest of you have been contributing to the discussion, but you also need to email me the answers to all the supply and demand questions on the first question set. You may hold off on the questions on labor force groups and types of unemployment.

One issue raised by Emily and Tek Nei is the status of the good. Is it necessary for people to live? One example is food during wartime. Then it might be necessary to limit prices and ration food through some other means such as food coupons or stamps. Does medical care fall into this category? In some countries (Germany for eg.) it is considered to be essential and everyone has a right to it. Prices are set by the government and medical expenses are paid for by revenues from taxes on workers and employers. The problem with controls on prices is that, if the price is set to low to allow sellers to recover their costs of production, supply may decrease or flow into black-market channels.

The justification for using free markets to ration goods is stronger when incomes are more equally distributed. Where there are gross differences between rich and poor, it is more difficult to say that only those able to pay for goods should be able to have them.

Instead of limiting prices would it be better to subsidize purchases by lower-income families? We do this in some important cases: housing and education.

Wilma and Amir raise the possibility of price controls to stop rampant inflation. We did have general price controls in the early 1970s and othe countries have used them since that time, Brazil in the 1980s for eg. It is usually thought better to control wages and let the decline in costs to employers ease the pressure on prices. Workers are not likely to support this policy so it takes a government which is independent of labor support of authoritarian to freeze wages.

#2. Different goods or services have different target market. If their target market are people who have higher income, the price of those goods or services are high. People with lower income can't afford to buy them. I think it is an acceptable outcome, when producers or suppliers set their goods or services at a high price, it means their products are for consumers who have high income.

Q#2: If the good or service is a luxury purchase, such as jewelery or first class travelling, then it shall be considered fair in the current market according to the income of the consumer.If the consumer is willing but not able to purchase luxury products, then he/she shall not(c'est la vie!). However, if the product is a nessecity, and prices have increased dramatically, then this shall not be considered fair conduct by the consumer, because the consumer understands the economist society, but not when it comes to necessity.

Unaffafordable goods are fair in a free market economy unless the scarcity of these goods is detremental to a population or to the economy itself. Then price controls may need to be imposed.

2. As long as the high priced good or service is not essential, the outcome should be fair. Luxury goods and services are certainly unnecessary, proving a fair market. Due to the scarcity of these luxury goods and services they will clearly be high priced. Only those who can afford those items will be able to purchase them.

#2. If the market price on a certain good is so high that many people cannot afford to buy it seems unfair to the consumer. However, luxury goods are part of a high priced market that many people cannot afford. At this point consumers must realize that luxury goods are based on quality and scarcity. This will increase price. Only those who can afford such goods will buy the goods. Such goods may be a private jet aircraft, boats, and/or diamond jewelry.

As far as to question one, I am not sure I completely understand it. Please explain.

#1. During a war or any time normal market forces are interrupted. In the 1970's during the oil embargo the supply of oil was suddenly diminished creating extraordinary hardship. Price controls were put into place hand in hand with rationing at heightened but reasonable prices, avoiding profiteering and hoarding.

#2. The word fair is a subjective word. Except for extraordinary circumstances price control in a free market should not be necessary. When market forces are allowed to operate prices will eventually go to the equilibrium price. If the good or service is a non-essential item only those who can afford it will be able to purchase it. The price of diamonds is manipulated, only so many are mined each year keeping the supply low and the price high. Diamonds are not a necessity and no one suffers an extraordinary hardship because of the high price.

2. Yes, only the first set of questions are due next week.

3. Once you have constructed a supply and demand graph, think of the shifts as right and left rather than up and down. An increase in both demand and supply is indicated by a right shift of the curve. Whereas a decrease in either one is a shift of that curve to the left. Increase means right and decrease and means left. Forget the up and down shifts, that wording creates confusion. I have two new and final questions on supply and demand.

1.Can you think of a situation when price controls, that is, limiting price increases might be appropriate?

2. If the market price is so high that many people cannot afford to buy a good or service is that a fair outcome?

Emily the review questions can be found on the syllabus part of this page. Click on the syllabus and then look, find, and click the Review Questions #1.

Q#2: The three most important secondary determinants of demand are: a)The wants of the buyer for that prouct. b)The buyers income. c)The prices of other goods.

Q#3 The supply curve slopes upwards because the price and the quantity supplied correspond to each other, rather than creating an inverse effect. Therefore, goods will be produced at a higher quantity for a higher price and vice versa.

Q2 - The general determinants of demand are a consumer's tastes, the number of consumers, their income, their future expectations of their income and prices, and the prices of related products. One of the most important secondary determinants of deman is the consumer's taste and preferences. There are many factors for people's tastes to change, new inventions of better products, new information about existing products that are better and even popularity (which advertising can effect). A good example is when Rosie O'Donnell created the Tickle Me Elmo craze. The popularity increase in the toy greatly contributed to it's high deman (and extremely high costs). Another determinant is the number of buyers in the market. An increase in buyers will increase demand, and vice versa, a decrease in buyers will decrease demand. The baby boom generation is a good group to follow because you can watch the shift in products that are in demand, from diapers... to persoanal computers about now. Another determinant of demand is changes in money income. The types of products that are in demand when incomes change vary. Superior or Normal goods vary directly with money income. Inferior goods vary inversely with money income.

Alfonso- Think of demand and supply decision as a matter of equalizing two factors. For consumers it is what they pay-price and what they get utility. While for sellers it is what they get-again price- with what they give up- the cost of producing the product.

The supply curve slope upward because as prices increase, manufacturers would be tempted to produce more because if they can sell more products at a higher price, they would make a better profit. So, if prices increase, the quantity supplied also increases. Thus, there is a positive relationship between the two.

Professor, I'm not sure to understand exactly what is individual and market demand. It's on page 44 of the book with table 3-2. I don't get the "first buyer, second buyer..."

2)Determinants of demand are consumer's tastes and preferences,the number of consumers in the market, and consumer incomes. Other determinants are prices of related goods and consumer forecasts for future prices and incomes.

3)As price increases and quantity increases the curve slopes upwards, because producers will manufacture more goods if they are selling them at a high price, to maximize their profits.

Dr. Garrett, i don't really sure the answer for the question 2, i hope what i wrote is correct #2. The three most important, secondary determinants of demand are (1) consumers' tastes and preferences, (2) the number of consumers in the market. (3) consumers' money incomes.

#3. When price rises, producers will produce more products. When price falls, producers will produce less products. It is because they want to sell their products at a high price. As a result, when price rises, the supply curve slope upward.

#1: As the price of the product shall decrease, the demand shall increase, due to the economic fact that consumers consume more of a product when its price decreases.

Also, if the price of a particular product increases, consumers are more likely to buy similar products and less of the product with the increased price.

Question#2: Three more important secondary determinants of demand are (1)consumers' tastes and preferences, (2)the number of consumers in the market, and (3)consumers' money incomes. These determinants are sometimes called demand shifters because a change in one or more of them will change the demand data.

Question#3: As stated in the law of supply, other things being equal, producers will offer more or a product at a higher price than at a lower price. As price rises, the corresponding quantity supplied rises, causing the supply curve to slope upward.

Question #2: Professor Garrett, I am not exactly sure what is meant by “secondary determinants of demand. I do know that the basic determinants of demand are 1) consumer’s tastes and preferences, 2) number of buyers in the market, 3) prices of related goods (substitutes, complements, and unrelated goods), 4) consumers’ money incomes, and 5) consumer expectations about future prices and incomes. Of these basic five determinants, I would think income, consumer expectations, and prices of related goods are the most important from a consumer’s point of view. The income of consumers is an important factor because income gives the consumer purchasing power. If consumers could afford to buy better goods (inferior) than this would shift the demand curve to the right (for the “better products”). In all actuality, with normal goods, that is, when income falls so does the demand for certain products, shifting the demand curve to the left.

Consumer expectations will also effect the demand curve. If consumer know that the prices of bottled water will rise next month, some consumer might buy more water this month, shifting the demand curve to the right. However, if consumer learn that a certain product is bad for the health and may cause certain diseases, the demand curve will shift to the left for this product.

Prices of related good also effect the demand curve. For example, good A and good B are substitutes. If the price of good A increases, the demand curve for good B will shift to the right. Consequently, the demand curve of good A will shift to the left. Now, if good C and good D are complements, the fall in the price of good C, the demand curve for good D will shift to the right. The rise in the price of good D could shift the demand curve for good C to the left. Unrelated goods basically have little of no effect on each other.

Question #3: The supply curve slopes upward because, as price rises, the quantity supplied also rises, other things being equal. This shows a positive slope. The supplier will produce more goods at a higher price. Price and quantity are directly related, whereas in demand, price and quantity are inversely related. Thus, the demand curve slopes downward and the supply curve slopes upward.

The supply curve slopes upward as the price of goods or services increases because producers are willing to produce more. The law of supply states that, other things equal, producers will offer more of a product at a higher price than at a lower price. The relationship between price and quantity is positive and supply is graphed as an upward sloping curve.

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Why does the supply curve slope upward?