Ch16 Answer Key, Intro to Economics

1) No; M1 is part of M2, so M2 is always greater than (or equal to) M1.

2) DMS = (1/Required Reserve Ratio) * DMonetary Base

DMS = (1/0.15) * -100 = $666.66

3) Large countries are prone to regional differences in economic activity. The Great Lakes (or “Rust Belt”) region could be experiencing prolonged hardships while the East Coast, West Coast, and South boom. If some regions stagnate while others experience inflation pressures, the desired monetary policy will vary across regions. It is important that each area has equal representation in setting policy. Currently, the West is underrepresented, as San Francisco is the only Fed Branch in the West.

The EU, now that it has formed a common currency area, is faced with similar problems. Countries like Ireland have thrived for years and are at great risk of experiencing rapid inflation. Other countries, however, commonly fall into recessions. The desired policy across international borders is often conflicting.

4A) It is really easy to increase the supply of paper money, but very hard to increase supply of commodity money. An increase in supply of an object causes its value to go down. That is, an increase in the amount of money available leads to inflation, a decrease in the purchasing power of that money.

4B) The difficulty of changing the supply of commodity money implies that monetary policy is not available for economic stabilization. On the other hand, some countries that use paper money often pay for their debts by printing more cash, which leads to disastrous economic outcomes (rapid inflation). Commodity money prevents this from occurring. Extreme libertarians fear the instability in the value of fiat money, and instead prefer a monetary system in which the currency is backed by gold. Check out this article on the Ron Paul Liberty Dollar: http://www.washingtonpost.com/wp-dyn/content/article/2007/11/16/AR2007111602267.html

5A) Like the gold-standard, the baby-sitting coupons are an example of a paper currency that is backed by a commodity (baby-sitting hours). The system is a hybrid between commodity and fiat money.

5B) As a medium of exchange, it works only within the co-op. Presumably, some people may be willing to give up coupons for other goods and services (to borrow a cup of sugar, perhaps). Notice, however, that people ceased using the coupons to exchange services when the money supply was tight.

It is doubtful that anyone in the co-op uses the coupons as a unit of account. As a store of value, the coupons are only good as long as your children remain young. (They lose substantial value when your kids go to college).