FUNDAMENTALS OF BUSINESS ECONOMICS

Answer to Recommended Problems #2

Chapter 7

5. 

Checking accounts = ¥500 million, required reserve ratio = 0.15 => required reserves = ¥75 million

Reserves = ¥85 million => excess reserves = ¥10 million

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12.

a.  Deposits = 500,000, required reserve ratio = 0.25 => required reserves = 125,000

Reserves = cash in vault and deposits at central bank = 60,000 + 100,000 = 160,000 => excess reserves = 35,000

b.  35,000

c. 

d.

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Chapter 8

2.

Chapter 9

9.  You should show the graph of each of these.

a.  Decrease in money supply => decrease in supply of loanable funds => real risk-free interest rate increases

b.  Decrease in global lending => decrease in supply of loanable funds => real risk-free interest rate increases

c.  Increase in private saving => increase in supply of loanable funds => real risk-free interest rate decreases

d.  Increase in budget deficit => increase in demand for loanable funds => real risk-free interest rate increases

e.  International capital inflows => increase in supply of loanable funds => real risk-free interest rate decreases

f.  Increase in real GDP

=> more income for households => increase in saving => increase in supply of loanable funds => real interest rate decreases

=> more profits for business, higher returns on portfolios => increase in business saving => increase in supply of loanable funds => real interest rate decreases

=> budget surplus increases => increase in supply of loanable funds => real interest rate decreases

=> imports increase => net exports decrease => money spent on imports flows back into country => increase in supply of loanable funds => real interest rate decreases

=> greater opportunities => borrowing by businesses increases => increase in demand for loanable funds => real interest rate increases

=> government budget deficit falls => decrease in demand for loanable funds => real risk-free interest rate decreases

=>  net impact is uncertain

g.  Increase in expected inflation rate

 => households spend to beat price increases =>  decrease in supply of loanable funds => real interest rate increases

=> businesses spend on assets to beat price increases =>  decrease in supply of loanable funds => real interest rate increases

=> households borrow more to spend to beat price increases => increase in demand for loanable funds => real interest rate increases

=> businesses borrow more to invest in anticipation of higher prices => increase in demand for loanable funds => real interest rate increases

=> foreigners borrow more to invest in anticipation of higher prices => increase in demand for loanable funds => real interest rate increases

=> real interest rate increases

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Chapter 10

9.  You should show the graph of each of these.

a.  Decrease in AS => P increases, real GDP decreases

b.  Decrease in AD => P decreases, real GDP decreases

c.  Decrease in AD (increase in IM, decrease in NE) => P decreases, real GDP decreases

d. Decrease in AD (increase in T, decrease in G) => P decreases, real GDP decreases

e.  Increase in AD (increase in C) => P increases, real GDP increases

f.  Decrease in AS => P increases, real GDP decreases

g.  Decrease in AD (decrease in C) => P decreases, real GDP decreases

h.  Increase in AD (increase in G, decrease in T) => P increases, real GDP increases

i.  Increase in AD (increase in G, increase in I or C) => P increases, real GDP increases

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Chapter 13

3.  This means that a market basket is 32 percent higher England that it is in the U.S.  To illustrate, suppose the nominal exchange rate of $ / £ is US$2 / 1£.  Suppose the market basket costs US$100 in the U.S. and 66£ in England.  That gives the real exchange rate of 1.32:

Real _{$ / £} = Nominal _{$ / £}  * Price _£ / Price _$ = US$2 / 1£ * 66£ / US$100 = 1.32

The arbitrage opportunity is to take 50£, exchange it for US$100, buy the basket in the U.S. and sell it for 66£ in England.  To eliminate the arbitrage opportunity, the $ / £ exchange rate should be US$1.515 / 1£. In this case, the British pound is overvalued.

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8.  You should show graphs for each of these:

a.  Demand for pesos increases (Argentina more attractive, supply of pesos decreases (Sweden less attractive) => price of pesos in krone increases

No impact on the monetary base

b.  Increase in Argentina's GDP relative to Sweden => imports increase => supply of pesos increases, price of pesos in krone decreases

No impact on the monetary base

c.  Swedish prices relatively less expensive => imports increase, exports decrease => supply of pesos increases, demand for pesos decreases => price of pesos in krone decreases

No impact on monetary base

d.  Demand for pesos increases => price of pesos in krone increases

Monetary base decreases as central bank buys pesos and takes them out of the market

e.  Supply of pesos increases => price of pesos in krone decreases

No impact on monetary base

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Chapter 14

6. 

b.  Croatia has a current account deficit, which means it is not "living within its means."

c.  Overall balance = current account + capital account = -310 + 355 = +45

d.  The reserves account balance is negative, which means that Croatian kuna are flowing out of the country.  This means that the Croatian central bank must be intervening in the foreign exchange market by selling kuna and buying reserves (dollars, euros, yen, etc.).

What happened is that 310 million kuna flowed out of Croatia due to current account transactions, while 355 million flowed into the country in capital account transactions.  The extra 45 million were sold by the Croatian central bank through its intervention in the foreign exchange market.

e.  The supply of kuna has increased due to central bank intervention, which should cause the kuna to decrease in value.

f.  Since the kuna is going to depreciate in value, acquiring kuna or assets denominated in kuna will decrease your company's profitability.  This would imply reduced investment and operations in Croatia.