Assignment: PRINCPLES OF MAC
Part 1
1. Between the early 1960s and late 2000s, bankers sought to raise and lend out more deposit funds. Today, however, a number of banks have stopped trying to attract more deposits. A few are even actively discouraging deposits by charging customers fees if they deposit "too many" funds. Why have bankers' views about the desirability of increased deposits shifted so dramatically in recent years?
Low Returns on Lending
One key reason that banks have soured on deposits is that earnings they can anticipate from lending deposit funds are now very low. In today's dampened U.S. economy, many fewer households and firms are seeking credit than in years past. As a consequence, banks have been competing with one another for a dwindling set of borrowers, and they have bid market interest rates on bank loans downward.
Thus, existing deposits are now yielding lower returns for banks. This fact gives them less incentive to seek out more deposits from current or new customers.
Higher Deposit Insurance Premium
Even as banks' returns from lending deposit funds have dropped, the costs they must pay for deposits have increased. Since 2006, the premium rate that banks must pay the Federal Deposit Insurance Corporation has jumped from close to zero to more than $0.30 per $100 of insured deposits-the highest rate since the FDIC's establishment in 1933.
The net result? Some banks have begun actively discouraging customers from substantially increasing their deposits. Recently, for instance, the Bank of New York Mellon began charging large depositors for the privilege of holding federally insured deposits. The bank now charges an annual interest fee of 0.13 percent to customers with deposit accounts of $50 million or more. Unless market loan rates rise and deposit insurance premiums fall, it appears likely that other banks will follow suit. Some banking experts speculate that eventually banks might begin charging interest fees to customers with small deposits.
a. Why do you suppose that the market clearing interest rates on bank savings and time deposits have fallen as the interest rates on bank loans have dropped?
b. If interest rates earned by banks on their assets fell close to zero, why might all bank customers have to pay interest fees on deposits they hold with banks?
Resources
To take a look at the latest statistics on the status and performance of U.S. commercial banks.
For a look at historical U.S. commercial banking data.
2. During the late 1970s, prices quoted in terms of the Israeli currency, the shekel, rose so fast that grocery stores listed their prices in terms of the U.S. dollar and provided customers with dollar shekel conversion tables that they updated daily. Although people continued to buy goods and services and make loans using shekels, many Israeli citizens converted shekels to dollars to avoid a reduction in their wealth due to inflation. In what way did the U.S. dollar function as money in Israel during this period?
3. Let's denote the price of a nonmaturing bond (called a consol) as Pb. The equation that indicates this price is Pb = I/r, where I is the annual net income the bond generates and r is the nominal market interest rate.
a. Suppose that a bond promises the holder $500 per year forever. If the nominal market interest rate is 5 percent, what is the bond's current price?
b. What happens to the bond's price if the market interest rate rises to 10 percent?
c. Imagine that initially the market interest rate is 5 percent and at this interest rate you have decided to hold half of your financial wealth as bonds and half as holdings of non-interest-bearing money. You notice that the market interest rate is starting to rise, however, and you become convinced that it will ultimately rise to 10 percent.
d. In what direction do you expect the value of your bond holdings to go when the interest rate rises?
e. If you wish to prevent the value of your financial wealth from declining in the future, how should you adjust the way you split your wealth between bonds and money? What does this imply about the demand for money?
4. Consider the following data: The money supply is $1 trillion, the price level equals 2, and real GDP is $5 trillion in base-year dollars. What is the income velocity of money? Suppose that the money supply increases by $100 billion and real GDP and the income velocity remain unchanged.
a. According to the quantity theory of money and prices, what is the new equilibrium price level after full adjustment to the increase in the money supply?
b. What is the percentage increase in the money supply?
c. What is the percentage change in the price level?
d. How do the percentage changes in the money supply and price level compare?
Part 2
1. The natural rate of unemployment depends on factors that affect the behavior of both workers and firms. Make lists of possible factors affecting workers and firms that you believe are likely to influence the natural rate of unemployment.
2. Suppose that people who previously had held jobs become cyclically unemployed at the same time the inflation rate declines. Would the result be a movement along or a shift of the short-run Phillips curve? Explain your reasoning.
Suppose that the greater availability of online job placement services generates a reduction in frictional unemployment during an interval in which the inflation rate remains unchanged. Would the result be a movement along or a shift of the short-run Phillips curve? Explain your reasoning.
3. During the first half of the 1960s, two island countries with nearly identical levels of per capita real GDP-about $2,700-and the same populations-just over 1,700,000 at that time-became independent nations.
One was Jamaica, and the other was Singapore. Since that time, Jamaica's population has grown to 2,700,000 people. Singapore's population has grown to 3,500,000. Today, Jamaica's per capita real GDP is about $4,800. In contrast, Singapore's per capita real GDP exceeds $31,000.
Why has Jamaica's per capita real GDP grown so much less than Singapore's, even though Singapore's population has increased at a faster pace? The fundamental answer is that people in Jamaica have considerably less economic freedom. In contrast to Singapore, which has business taxation and regulations rated among the least burdensome in the world, tax rates and regulatory rules in Jamaica rank among the most oppressive. As a consequence, rates of growth of saving, investment, and productivity-and, hence, per capita real GDP-in Jamaica have been far below corresponding growth rates in Singapore.
In Jamaica, the cost of registering a business is 13 percent of the value of a firm's capital, as compared with less than 0.2 percent in Singapore. In which country would you guess that more new companies are started each year?
4. Part A. A nation's current annual rate of growth of per capita real GDP is 3.0 percent, and its annual rate of population growth is 3.4 percent. What is the nation's annual rate of growth of real GDP?
Part B: Assume that each $1 billion in net capital investment generates 0.3 percentage point of the average percentage rate of growth of per capita real GDP, given the nation's labor resources. Firms have been investing exactly $6 billion in capital goods each year, so the annual average rate of growth of per capita real GDP has been 1.8 percent. Now a government that fails to consistently adhere to the rule of law has come to power, and firms must pay $100 million in bribes to gain official approval for every $1 billion in investment in capital goods. In response, companies cut back their total investment spending to $4 billion per year. If other things are equal and companies maintain this rate of investment, what will be the nation's new average annual rate of growth of per capita real GDP?
Part 3
1. The production of linen requires twice as much land and labor as the production of an equivalent amount of cotton. Nevertheless, linen is a staple material utilized in designer clothing, such as women's blazers and dresses with prices exceeding $2,000, men's trench coats that sell for more than $1,500, and wedding gowns priced above $5,500.
Two-thirds of the world's linen is derived from a fiber called flax that is harvested within a narrow belt of farmland stretching from northern France into the Netherlands. The European coastal climate provides alternating sunshine and rain that contribute to development of a fungus that grows on the flax stems. The fungus breaks down the stems so that the linen fibers can be more readily separated from the plants. Thus, farmers residing this area are able to produce flax at a lower opportunity cost, in terms of forgone production of other goods, than almost anywhere else on the planet. This fact explains why this region of Europe has a comparative advantage in growing flax and specializes in the production of linen.
Why do you think that linen production generates gains from trade for European producers of flax and linen, even though cotton-based fabrics can be produced at lower absolute cost in many other parts of the world?
2. The U.S. Export-Import (Exim) Bank regularly extends about $100 billion in subsidized loans to foreign buyers of U.S.-manufactured products, including aircraft, hair-care products, and construction equipment. The Exim Bank's extensions of taxpayer-subsidized credit to companies in other nations gives these foreign firms incentives to buy U.S. exports.
Airlines based in the United States are not enthused about aircraft-loan subsidies to competitors based in other nations, however. The U.S. airlines argue that the Exim Bank's low-interest loans to foreign carriers provide a cost advantage that enables the foreign airlines to compete at lower expense in the international air transportation market. Thus, from the U.S. airlines' point of view, U.S. taxpayers are subsidizing their foreign competitors.
Why do you suppose that some U.S. makers of hair-care products and certain U.S. construction contractors that bid for work in other nations have lodged complaints similar to those of the U.S. airlines?
3. Among the imported items for which the 1991 legislation sharply reduced U.S. tariff rates were Colombian cut flowers. The Colombian climate is superior to that of the western United States for growing most flowers, and Colombian farm labor costs are much lower. Thus, within a few years after the reduction in tariffs, Colombian flower growers had established a network for selling cut flowers in California.
Furthermore, in 2010, the Colombian firms opened a large distribution center in Los Angeles to increase the flow of cut-flower imports into the United States. As Figure 32-7 on page 721 of your textbook indicates, Colombian flower growers' efforts led to a substantial increase in U.S. flower imports from that nation during the 2000s. By 2010, U.S. imports of Colombian cut flowers were nearly 400 percent greater than the 2002 level. As Colombian flower imports into California bloomed, the sales of cut flowers by California growers shriveled. When Congress passed the Andean Trade Promotion Act, there were 450 Californian flower farms. By 2010, there were 250.
In response to the upsurge in competition from Colombia, the California Cut Flower Commission, a trade association, successfully lobbied to delay congressional approval of a renewal of the Andean regional trade pact. The consequence was a re-imposition in 2011 of tariffs on Colombian flower growers, whose tariff payments increased sharply. As shown in Figure 32-7 on page 721, this significant tariff increase resulted in a considerable reduction in cut-flower imports from Colombia. As a consequence, the foreign supply of cut flowers in California decreased, and the demand for Californian cut flowers increased, which pushed up U.S. prices of cut flowers. Even as California flower growers' earnings flourished, they began lobbying for U.S. government subsidies to enable them to establish their own cut-flower distribution center to compete with Colombia's.
a. Which region appears to have a comparative advantage in producing cut flowers: Colombia or California? Explain.
b. How have U.S. consumers of cut flowers been affected by the cutback in Colombian imports?
Resources
Find out more about the Columbian Trade Promotion go to USTR.
Learn about the Colombian flower industr.
4. Suppose that the People's Bank of China wishes to peg the rate of exchange of its currency, the yuan, in terms of the U.S. dollar. In each of the following situations, should it add to or subtract from its dollar foreign exchange reserves? Why?
a. U.S. parents worrying about safety begin buying fewer Chinese-made toys for their children.
b. U.S. interest rates rise relative to interest rates in China, so Chinese residents seek to purchase additional U.S. financial assets.
c. Chinese furniture manufacturers produce high quality early American furniture and successfully export large quantities of the furniture to the United States.
Format your assignment according to the following formatting requirements:
1. The answer should be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides.
2. The response also includes a cover page containing the title of the assignment, the student's name, the course title, and the date. The cover page is not included in the required page length.
3. Also include a reference page. The Citations and references should follow APA format. The reference page is not included in the required page length.