Group B Discussion: Influences of Monetary and Fiscal Policy (Ch.34)

1. What is the theory of liquidity preference and how does it help explain the downward slope of the aggregate demand curve?

John Maynard Keynes came up with the theory of liquidity preference to explain short-term determination of an economy's interest rate. The interest rate adjusts to try to achieve equilibrium in the money market between the supply and demand of money. This is explained by the downward slope of the aggregate demand curve, which illustrates the negative relationship between the price level and the quantity of goods and services demanded. An increase in the price level causes an increase in the demand for money, and thus an increase in the interest rate as well. This reduces the quantity of goods and services demanded.

2. Use the liquidity preference theory to explain how decreases in the money supply affect the AD curve.

A decrease in the money supply causes a raise in the interest rate and reduces the quantity of goods and services demanded for any given price level. This shifts the aggregate demand curve to the left.

3. Give an example of a government policy that acts as an automatic stabilizer. Explain why the policy has this effect.

When the country falls into an economic recession, the government policy of collecting taxes, particularly personal income, payroll, and corporate income taxes, functions as an automatic stabilizer. A high amount of revenue from these taxes is tied to economic prosperity. The more people are paid, the more money companies earn, the higher the government's tax revenue. The short-term lower taxes stimulate aggregate demand and automatically help prevent severe economic fluctuations.

Chapters 29 & 30: Group B Discussion

1. What do we mean when we say, "money is whatever society says it is?"

Money can be whatever society as a whole deems valuable. Money is an imperative element of the economy because it is essential in exchanging goods and services between buyers and sellers.

2. Describe the components of M1, M2 and M3. In general, how do they differ?

M1 includes the total amount of physical currency outside the banking system, demand deposits, traveler's checks, and other checkable deposits.
M2 includes M1, savings deposits, small time deposits, and money market mutual funds.
M3 includes M2, large time deposits, deposits of eurodollars, and repurchase agreements.

3. What is "the Fed" and its main purpose?

The "Fed," or Federal Reserve, is responsible for controlling the supply of money in the economy. It also regulates banks and makes sure the banking system is in a healthy financial condition.

4. Take a look at the following banking in-class demonstrations. Pick one of the three demos to perform with some friends, relatives, or other persons who owe you a favor:-) 

1. Which demonstration did you choose and why?
I chose the money creation demonstration because I was curious to know more about how the Federal Reserve and the banking system facilitate expansion of the money supply.

2. Give a general description of your volunteers - approx age, gender, etc.

My volunteers were my mother and her two friends. They are women in their late forties with a basic understanding of economics. My mom is a teacher, one of her friends is a writer, and the other is a lawyer.

3. How did the demonstration go overall?
I would say the demonstration went relatively well. While I had to go through it twice because we couldn't figure out exactly how to set up the activity, in the end we all understood the concept of banks expanding the money supply. We recorded each transaction on a balance sheet, which helped compare the ending bank deposits to the initial amount of money spent by the Fed.

4. Did the volunteers seem to understand the concept being demonstrated? Why or why not?
My volunteers seemed to genuinely understand the concept. They understood liabilities and assets, and the balance sheet was definitely useful.

5. Add any other comments you feel are relevant.
I think for this demonstration, participation is key to understanding the process. I tried to explain what would happen at first with no luck, but once my volunteers became involved in the money exchange, the concept was much easier to comprehend.

6. Did you enjoy this exercise and did you learn anything new by performing the demonstration? Why or why not?
I enjoyed this exercise because I feel like everything clicked and I understand the concept perfectly now (at least I think so). This demonstration brought clarity to the role of the Fed and banking system in expanding money supply.

Chapter 24: Group B Discussion

1. What is the CPI and what is its purpose?

The CPI, or consumer price index, takes a look at a typical consumer, and the overall cost of goods and services they purchase. The CPI is calculated by the Bureau of Labor Statistics.

2.

Year	Price of Footballs	Price of Basketballs
Year 1	$10	$12
Year 2	12	15
Year 3	14	18

Basket = 3 footballs, 4 basketballs

Cost of Basket
Cost in Year 1:  (10*3)+(12*4)= $78 per basket
Cost in Year 2:  (12*3)+(15*4)= $96 per basket
Cost in Year 3:  (14*3)+(18*4)= $114 per basket

CPI
CPI in Year 1:  ($78/$78)*100= 100
CPI in Year 2:  ($96/$78)*100= 123
CPI in Year 3:  ($114/$78)*100= 146

Inflation Rates
Inflation rate for Year 2: (123-100)/100= 0.23, or 23%
Inflation rate for Year 3: (146-123)/123= 0.187, or 19%


3.   Take a look at the following link. Notice all the different measures of a country's "Standard of Living." Which do you think is the best measure and why?

The quality-of-life index seems to be the best and most comprehensive measure of a country's "Standard of Living," as it takes multiple factors into account as opposed to the GDP only or homeownership only indexes. The quality-of-life index measures social, economic, and political variables such as GDP per capita, life expectancy, political stability, job security, and more.