NED UNIVERSITY OF ENGINEERING & TECHNOLOGY

Economics and Management Science Department

EC- 304 Money and Banking

Assignment 02 Date of Submission 10TH November 2021

1. Describe four ways you could pay for your morning cup of coffee. What are the advantages and
disadvantages of each? (LO2)

Answer: You could use money, a check, or a debit card.

Money: This is the most likely to be accepted, but it means you have to replenish your supply periodically.

Check: The least likely to be accepted, and it means you have to walk around with your checkbook. But
the funds remain in your bank account for the time it takes the check to make its way through the clearing
system.

Debit Card: This is very convenient, and likely to be accepted. But when the electronic signal arrives at
your bank later in the day, the funds are withdrawn immediately from your account.

Mobile Payment App: This is very convenient and fast, as you can complete payment with a simple tap
of your mobile device. But you are vulnerable to hackers possibly accessing your information.

2. You are the owner of a small sandwich shop. A buyer may offer one of several payment methods: cash, a
check drawn on a bank, a credit card, or a debit card. Which of these is the least costly for you? Explain
why the others are more expensive. (LO2)

Answer: Cash is the cheapest option for the merchant; no information is required about the buyer and no
additional costs are imposed (though the merchant may need to guard against counterfeiting). Most
merchants will ask for a government-issued photo ID in order to accept payment by check, requiring more
time per transaction. Even with appropriate identification, the merchant does not know if funds are actually
available in the check writer’s account. If not, the merchant will likely undergo a costly process of
contacting the buyer and trying to coax the funds from the individual. A payment by credit card provides
the merchant with more protection than does a check because the payment is made by the financial
institution issuing the card. However, the merchant pays the card issuer a fee (usually a percentage of the
transaction value) for the certainty of the payment. Finally, while a debit card electronically transfers funds
from the buyer’s account to the merchant’s, this transfer is not instantaneous, and the buyer is likely
already gone when the merchant may discover that the buyer did not have the funds available.

3. Explain how money encourages specialization, and how specialization improves everyone’s standard of
living. (LO1)

Answer: Without money, people have to barter to exchange goods and services. This requires a “double
coincidence of wants,” which makes it difficult to specialize. In the example in the text, a plumber is
buying groceries; if the grocer doesn’t need a plumbing repair, but does need the outside of his store
painted, the plumber may decide to paint the store in order to pay for his groceries even though it is not
what he does best. When money is used, people are free to specialize in areas in which they have a
 comparative advantage, increasing the production of society as a whole, and improving everyone’s
standard of living.
4. *Could the dollar still function as the unit of account in a totally cashless society? (LO2)

Answer: Yes. Using dollars and cents to quote prices and record debts does not depend on cash being
used as a means of payment. Dollars and cents may still serve as the standard measurement of value even
if they are not themselves exchanged.

5. Why might each of the following commodities not serve well as money? (LO2)
a. Tomatoes
b. Bricks
c. Cattle

Answer:
a. Tomatoes are perishable and thus would not serve as a store of value.

b. Bricks are heavy and bulky and will break easily. In addition, even though bricks break easily, they
are not easily divisible into usable units.

c. Cattle are not standardized in terms of weight and other potentially important characteristics.

6. What do you think accounts for the wide-spread adoption of mobile-based payment services in emerging
economies? (LO2)

Answer: In these countries, large segments of the population may have lacked access to more traditional
bank-based payment mechanisms. Technological innovations enable mobile phone-based payment
services to reach many people at a relatively low cost, especially those living in remote, rural areas.

7. Under what circumstances might you expect barter to reemerge in an economy that has fiat money as a
means of payment? (LO2)

Answer: You might expect an economy to revert to barter when the public loses confidence in the fiat
money issued by the government, perhaps because of overuse of the printing presses. For example, this
has happened during episodes of extremely high inflation, such as that experienced in Zimbabwe during
much of the 2000's.

8. What factors should you take into account when considering using the following assets as stores of value?
(LO1)
a. Gold
b. Real estate
c. Stocks
d. Government bonds
e. Cryptocurrencies

Answer: When assessing an asset as a store of value, the primary things to consider are the risk and return
of the asset and its liquidity.
a. In considering keeping gold as a store of value, one must consider the potential for the price of
gold to rise, the ability to buy and sell gold easily, and the costs associated with the storage and
security of gold.

b. In considering keeping real estate as a store of value, one must consider the rate at which real estate
is appreciating and is likely to appreciate in the future, how easy or difficult selling is, and the
housing services you could receive from holding the real estate
 c. In considering keeping stocks as a store of value, one must consider the potential appreciation in
the nominal value of the stock, the historical volatility of the stock's price, and the volume of the
stock being traded on the secondary market (in order to gauge its liquidity).

d. In considering keeping government bonds as a store of value, one must consider the rate of return
on the bonds, including interest payments and any potential capital gains, as well as the ease with
which you can buy and sell the bonds.

e. In considering keeping cryptocurrencies as a store of value, one must consider their stability,
including their ease of use as a means of payment and value

9. *Under what circumstances might money in the form of currency be the best option as a store of value?
(LO1)

Answer: If there were deflation in the economy, then paper currency would increase in value. When
deflation occurs, overall prices in the economy are falling and so the currency you hold has more
purchasing power. During periods of falling prices of goods and services, prices of assets often fall too
and so currency might be an attractive option as a store of value.

10. *Consider an economy that only produces and consumes two goods—food and apparel. Suppose the
inflation rate based on the consumer price index is higher during the year than that based on the GDP
deflator. Assuming underlying tastes and preferences in the economy stay the same, what can you say
about food and apparel price movements during the year? (LO3)

Answer: Since the two price indices yield different inflation rates with preferences remaining constant,
the relative price of the two goods must have changed. In other words, the price of one of the goods must
have gone up by a greater percentage than the other. For example, suppose the price of food went up by
10% while the price of apparel went up by 20%. This would induce consumers to substitute food for
apparel. As a fixed weight index, the CPI would not take this substitution into account while the GDP
deflator would, as it is calculated on the basis of what is actually purchased. Therefore, the CPI inflation
rate would be higher than the rate calculated from the GDP deflator.