16 On Money

Chapter Sixteen On money

Self-assessment Questions

16.1(a) Currency in circulation possesses perfect acceptability since it is a legal tender. Demand
deposits are not as acceptable as currency in circulation.

16.1(b) Demand deposits are more convenient than currency in transactions involving large
amount.

16.2 John should put the money in a time deposit account, because the interest return on time
deposits is the highest.

16.3 Gold could be a better form of money than paper money. This is because

1) gold is more durable than paper money.

2) the supply of gold is more limited than paper money.

3) the value of gold can be more stable than that of paper money.

16.4 Demand deposits are included in M2 because they are good stores of value. Yet, they are
included in M1 because they can serve as a generally acceptable medium of exchange for
settling transactions.

Hence, the statement is incorrect.

16.5 M1 will not be affected. The increase in demand deposits is matched by a corresponding
decrease in cash in the non-bank public.

M2 will not be affected. This is because neither M1, nor savings deposits, nor time deposits,
nor negotiable certificates of deposits with licensed banks is affected.

Multiple Choice Questions

1 A 2 A 3 A 4 B 5 B
6 A 7 B 8 B 9 D
10 A 11 B

2 Potatoes are divisible, so that (4) is wrong.

3 M2 will remain unchanged, because the drop in currency in public circulation is matched by a
corresponding increase in time deposit. Therefore, (4) is wrong.

8 When the note-issuing banks return some Certificate of Indebtedness to the Hong Kong
Monetary Authority for US dollars, they have to contract the currency supply.

9 There will be a decrease in demand deposits. With currency in public circulation, savings
deposits, time deposits and NCDs issued by the licensed banks held outside the monetary sector
remaining unchanged, M1 and M2 will necessarily fall.

New Introductory Economics 3rd Edition 38 © Pearson Education Asia Limited 2003
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 16 On Money

11 Bank notes are ‘inconvertible’ money in the sense that the issuing authority does not promise to
redeem it for ‘gold’ or ‘silver’ on request.

Short Questions

12 This country is more likely a desert country. One of the important properties of ‘good’ money is
that it is limited in supply. Shells are more limited in supply in a desert country.

In an island country surrounded by the sea on all sides, shells are likely to be in plentiful supply.
It is unlikely that the monetary authority can exert proper control over the supply of shells.

13 John is wrong. M3 does not equal M1 plus M2.

Mary is correct. By definition, M1 is a subset of M2, and M2 is a subset of M3. Hence, M1 is a

component of M3.

Structured Essay Question

14(a)(i) Demand deposits

14(a)(ii) Savings deposits, time deposits, and negotiable certificates of deposits issued by licensed
banks held outside the monetary sector

14(b) M1 is based on the medium of exchange function as it includes assets that serve as convenient
media of exchange.

M2 is based on the store of value function as it also includes assets that are good stores of
value.

14(c)(i) Demand deposits, because they enable him to withdraw his money at any time he chooses
and are therefore the most liquid bank deposits.

14(c)(ii) Time deposits, because the rate of interest on time deposits is the highest.

14(d)(i) Note-issuing banks have to buy Certificates of Indebtedness with US dollars at a rate of
HK$7.8 per US dollar from the Hong Kong Monetary Authority. Coins and new $10 notes
are issued by the Hong Kong Monetary Authority.

14(d)(ii) This is because Hong Kong currency supply is 100% backed up by foreign currency.

New Introductory Economics 3rd Edition 39 © Pearson Education Asia Limited 2003
Suggested Solutions