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Calculating the Money Supply in billions of dollars Checkable deposits (dem...

Mar 18, 2024

Calculating the Money Supply in billions of dollars Checkable deposits (demand deposits, NOW. ATM, and credit union share draft accoun(s)

\$ 1,500

Currency in circulation

\$ 1,000

Savings deposits

\$ 7,000

Small-denomination time deposits

\$ 500

Money market funds

\$ 600

(A)

\mathrm{Ml}=

(B)

\mathrm{M} 2=

Key Concept

M1 Money Supply

Explanation

M1 includes currency in circulation and checkable deposits. M1 = Currency + Checkable Deposits =

1,000 billion +

1,500 billion = $2,500 billion.

Key Concept

M2 Money Supply

Explanation

M2 includes M1 plus savings deposits, small-denomination time deposits, and money market funds. M2 = M1 + Savings Deposits + Small-Denomination Time Deposits + Money Market Funds =

2,500 billion +

7,000 billion +

500 billion +

600 billion = $10,600 billion.

11. In each of the following scenarios, identify the financial asset (loan, stock, bond, bank deposit) and what important function of financial markeis is being served (reduce trunsaction costs, reduce rish, provide liquidity). Explain how the asset is serving the function(s) you identify. Scenario Financial asset Function(s) (A) The cost of building a new faclory is financed by selling shares in the company. (B) Funds from many small savers are combined and provided to an individual to buy a house. (C) The

\$ 1,000

in your savings account at your local bank pays you 3 percent interest. (D) A firm borrows money by promising to pay a fixed sum of interest each year for 10 years and then pay back the amount borrowed at the end of 10 years.

Answer

(A) Financial asset: Stock; Function: Provide liquidity. (B) Financial asset: Loan; Function: Reduce risk. (C) Financial asset: Bank deposit; Function: Provide liquidity. (D) Financial asset: Bond; Function: Reduce transaction costs.

Solution

(A) Financial Asset: Stock - When a company sells shares, it is offering ownership stakes in the company

(A) Function: Provide liquidity - Stocks can be bought and sold on stock exchanges, which provides liquidity to the company and the investors

(B) Financial Asset: Loan - Funds from savers are pooled together by a financial intermediary, such as a bank, to provide a mortgage

(B) Function: Reduce risk - By pooling funds, the risk of lending is spread across many investors, reducing the risk for any single investor

(C) Financial Asset: Bank deposit - Your savings account is a deposit at the bank, which the bank can use to make loans to others

(C) Function: Provide liquidity - A savings account provides liquidity to the depositor, as they can withdraw their funds when needed

(D) Financial Asset: Bond - A firm issues a bond to borrow money from investors, promising to pay a fixed interest rate and return the principal at maturity

(D) Function: Reduce transaction costs - Bonds allow firms to raise large amounts of capital without having to negotiate terms with each individual lender

Key Concept

Financial markets facilitate the allocation of resources by providing liquidity, reducing risk, and lowering transaction costs.

Explanation

Financial assets such as stocks, loans, bank deposits, and bonds serve different functions in financial markets, each contributing to the efficient functioning of the economy by allowing for investment, savings, and the spreading of risk.