MONEY AND BANKING - ECON30005
UPDATED ACTUAL Exam Questions and
CORRECT Answers
What Are the Three Functions of Money? - CORRECT ANSWER - Medium of Exchange:
This function of money facilitates trade by eliminating the need for a double coincidence of
wants, meaning two parties each having a good or service that the other wants. Money can be
exchanged for goods and services, reducing transaction costs and making a market economy
possible.
Store of Value: As a store of value, money maintains its value over time. This allows individuals
to save it and use it in the future, enabling the transfer of wealth across different time periods.
Unit of Account: Money provides a common measure for recording prices, values, and financial
obligations. It offers a standard metric that helps in comparing the market value of different
goods and services.
What is M1? - CORRECT ANSWER - Includes the most liquid forms of money, like
currency in circulation and demand deposits (checking accounts).
What is M2? - CORRECT ANSWER - Adds slightly less liquid assets to M1, including
savings accounts and small time deposits (certificates of deposit).
What is M3? - CORRECT ANSWER - Broadens M2 by including large time deposits and
institutional money market funds.
What is Broad Money? - CORRECT ANSWER - the broadest measure of money in an
economy. It includes all assets in M3, plus other larger and longer-term deposits. This measure
encompasses virtually all assets that could potentially be used as a medium of exchange.
What Role Do Banks Play in Money Creation? - CORRECT ANSWER - Banks play a
pivotal role in money creation through a process known as fractional reserve banking. When a
bank receives a deposit, it keeps a fraction of it as reserves and lends out the rest. The money lent
out can then be deposited in another bank, which again keeps a fraction and lends out the rest.
This cycle can multiply the original deposit, effectively increasing the money supply.
,What Was the Use of Money in a P.O.W. Camp During WWII? - CORRECT ANSWER -
In POW camps during World War II, cigarettes were used as a form of currency. This showcased
the essential functions of money. Despite not being an official currency, cigarettes became a
medium of exchange, a store of value, and a unit of account within the camp. This unique case
study highlights that money can take any form, as long as it is widely accepted and fulfills these
three functions.
What is the Kiyotaki-Wright Model? - CORRECT ANSWER - An economic model that
illustrates the vital role of money as a medium of exchange amidst commodities. It proposes a
scenario where there are three types of agents, each producing a different good but consuming a
different one from what they produce. The model assumes that each agent seeks to maximize
their utility from consumption.
What is the Concept of Acceptability in the Kiyotaki-Wright Model? - CORRECT
ANSWER - The Kiyotaki-Wright model introduces the concept of acceptability (π),
indicating the ease or difficulty of trading a commodity or money. The acceptability parameter
influences the choice of the medium of exchange. If the value of money (VM) is higher than the
value of a commodity (VC), meaning a higher acceptability parameter for money, money will be
preferred as the exchange medium.
What Factors Influence an Individual's Choice of What to Hold in the Kiyotaki-Wright Model? -
CORRECT ANSWER - An individual's choice of what to hold in the Model is influenced
by the comparative ease of trade. If VM>VC, the individual prefers to hold and trade money. If
VM<VC, the individual prefers to hold and trade the commodity. If VM=VC, the individual is
indifferent between holding money or the commodity.
What Characterizes Equilibrium in the Kiyotaki-Wright Model? - CORRECT ANSWER -
Equilibrium is characterized by Individual Optimality and Aggregate Consistency. Individual
Optimality means each agent aims to maximize their utility, given their circumstances, making
the best decisions possible. Aggregate Consistency ensures that individual preferences and
actions are reflected at the societal level, meaning the overall actions and choices of individuals
align with societal behavior and preferences.
, What are the Limitations of the Kiyotaki-Wright Model? - CORRECT ANSWER - It does
not account for inflation or deflation, assumes constant acceptability parameters, and does not
consider potential credit or debt in the economic scenario.
How is the Value of Money and Goods Defined in the Kiyotaki-Wright Model? - CORRECT
ANSWER - the value of money (VM) or any good (VG) is defined as the sum of the
current and discounted future utilities that an agent expects to derive from holding that good. The
formula for VM when money can't be consumed directly is VM=U(O)+E[VM'], while the
formula for VG when the good can be consumed is VG=U(G)+E[VG'].
What is the Role of Money as a Medium of Exchange in the Kiyotaki-Wright Model? -
CORRECT ANSWER - Money acts as a medium of exchange when direct trade between
goods isn't possible due to distinct preferences of agents. Money, being widely accepted and
preferred, facilitates trade between agents, reinforcing its role as a crucial medium of exchange.
What is the Classical Dichotomy in macroeconomics? - CORRECT ANSWER - An
economic concept which separates real variables like output and employment from nominal
variables like money and prices
What assumptions does the classical model make? - CORRECT ANSWER - THE model
assumes that prices are flexible, markets are always in equilibrium, and that money is neutral.
This implies that changes in money supply only affect nominal variables and not real ones.
What are the implications of the Classical Dichotomy? - CORRECT ANSWER - If the
model holds changes in the money supply would affect price levels but not real economic
variables like output or employment. This suggests that the central bank can control inflation but
cannot affect long-term economic growth.
What is money demand in macroeconomics? - CORRECT ANSWER - Money demand
refers to the desire of households and businesses to hold assets in a form that can be easily
exchanged for goods and services.
What are the two key models of Money Demand? - CORRECT ANSWER - Classical
quantity theory of money and the Keynesian theory of liquidity preference.
UPDATED ACTUAL Exam Questions and
CORRECT Answers
What Are the Three Functions of Money? - CORRECT ANSWER - Medium of Exchange:
This function of money facilitates trade by eliminating the need for a double coincidence of
wants, meaning two parties each having a good or service that the other wants. Money can be
exchanged for goods and services, reducing transaction costs and making a market economy
possible.
Store of Value: As a store of value, money maintains its value over time. This allows individuals
to save it and use it in the future, enabling the transfer of wealth across different time periods.
Unit of Account: Money provides a common measure for recording prices, values, and financial
obligations. It offers a standard metric that helps in comparing the market value of different
goods and services.
What is M1? - CORRECT ANSWER - Includes the most liquid forms of money, like
currency in circulation and demand deposits (checking accounts).
What is M2? - CORRECT ANSWER - Adds slightly less liquid assets to M1, including
savings accounts and small time deposits (certificates of deposit).
What is M3? - CORRECT ANSWER - Broadens M2 by including large time deposits and
institutional money market funds.
What is Broad Money? - CORRECT ANSWER - the broadest measure of money in an
economy. It includes all assets in M3, plus other larger and longer-term deposits. This measure
encompasses virtually all assets that could potentially be used as a medium of exchange.
What Role Do Banks Play in Money Creation? - CORRECT ANSWER - Banks play a
pivotal role in money creation through a process known as fractional reserve banking. When a
bank receives a deposit, it keeps a fraction of it as reserves and lends out the rest. The money lent
out can then be deposited in another bank, which again keeps a fraction and lends out the rest.
This cycle can multiply the original deposit, effectively increasing the money supply.
,What Was the Use of Money in a P.O.W. Camp During WWII? - CORRECT ANSWER -
In POW camps during World War II, cigarettes were used as a form of currency. This showcased
the essential functions of money. Despite not being an official currency, cigarettes became a
medium of exchange, a store of value, and a unit of account within the camp. This unique case
study highlights that money can take any form, as long as it is widely accepted and fulfills these
three functions.
What is the Kiyotaki-Wright Model? - CORRECT ANSWER - An economic model that
illustrates the vital role of money as a medium of exchange amidst commodities. It proposes a
scenario where there are three types of agents, each producing a different good but consuming a
different one from what they produce. The model assumes that each agent seeks to maximize
their utility from consumption.
What is the Concept of Acceptability in the Kiyotaki-Wright Model? - CORRECT
ANSWER - The Kiyotaki-Wright model introduces the concept of acceptability (π),
indicating the ease or difficulty of trading a commodity or money. The acceptability parameter
influences the choice of the medium of exchange. If the value of money (VM) is higher than the
value of a commodity (VC), meaning a higher acceptability parameter for money, money will be
preferred as the exchange medium.
What Factors Influence an Individual's Choice of What to Hold in the Kiyotaki-Wright Model? -
CORRECT ANSWER - An individual's choice of what to hold in the Model is influenced
by the comparative ease of trade. If VM>VC, the individual prefers to hold and trade money. If
VM<VC, the individual prefers to hold and trade the commodity. If VM=VC, the individual is
indifferent between holding money or the commodity.
What Characterizes Equilibrium in the Kiyotaki-Wright Model? - CORRECT ANSWER -
Equilibrium is characterized by Individual Optimality and Aggregate Consistency. Individual
Optimality means each agent aims to maximize their utility, given their circumstances, making
the best decisions possible. Aggregate Consistency ensures that individual preferences and
actions are reflected at the societal level, meaning the overall actions and choices of individuals
align with societal behavior and preferences.
, What are the Limitations of the Kiyotaki-Wright Model? - CORRECT ANSWER - It does
not account for inflation or deflation, assumes constant acceptability parameters, and does not
consider potential credit or debt in the economic scenario.
How is the Value of Money and Goods Defined in the Kiyotaki-Wright Model? - CORRECT
ANSWER - the value of money (VM) or any good (VG) is defined as the sum of the
current and discounted future utilities that an agent expects to derive from holding that good. The
formula for VM when money can't be consumed directly is VM=U(O)+E[VM'], while the
formula for VG when the good can be consumed is VG=U(G)+E[VG'].
What is the Role of Money as a Medium of Exchange in the Kiyotaki-Wright Model? -
CORRECT ANSWER - Money acts as a medium of exchange when direct trade between
goods isn't possible due to distinct preferences of agents. Money, being widely accepted and
preferred, facilitates trade between agents, reinforcing its role as a crucial medium of exchange.
What is the Classical Dichotomy in macroeconomics? - CORRECT ANSWER - An
economic concept which separates real variables like output and employment from nominal
variables like money and prices
What assumptions does the classical model make? - CORRECT ANSWER - THE model
assumes that prices are flexible, markets are always in equilibrium, and that money is neutral.
This implies that changes in money supply only affect nominal variables and not real ones.
What are the implications of the Classical Dichotomy? - CORRECT ANSWER - If the
model holds changes in the money supply would affect price levels but not real economic
variables like output or employment. This suggests that the central bank can control inflation but
cannot affect long-term economic growth.
What is money demand in macroeconomics? - CORRECT ANSWER - Money demand
refers to the desire of households and businesses to hold assets in a form that can be easily
exchanged for goods and services.
What are the two key models of Money Demand? - CORRECT ANSWER - Classical
quantity theory of money and the Keynesian theory of liquidity preference.
