Question

The correct answers are already bolded, but please show your work/explain how you get the answer.

1. Rick can cut 6 pieces of wood or catch 6 fish per day. Timmy can cut 9 pieces of wood or catch 18 fish per day. Which one of the following points is not on the Timmy’s production possibility frontier fish is on the horizontal axis and pieces of wood is on the vertical axis?

a. (0, 9)

b. (18, 0)

c. (8, 5)

d. (10, 3)

2. Suppose that the banking system currently has $500 billion in reserves, the reserve requirement is 9% and the excess reserves are $5 billion. What is the level of loans?

a. $5,500 billion

b. $5,495 billion

c. $5,000 billion

d. $4,955 billion

3. Suppose interest of 5% for two years can be earned on $1,000 saved today with no risk. What is the least amount a person would need to have a 50% chance of winning to be willing to face a 50% chance of losing $1,000 today and be considered risk averse?

a. $907.03 to be paid in two years

b. $1,000.01 to be paid in two years

c. $1,100.01 to be paid in two years

d. $1,102.51 to be paid in two years

Answer 1

1. Rick cut 6 pieces of wood or can catch 6 fish per day. That means that for every fish caught he will have to forego cutting of 1 piece of wood, Similarly Timmy can catch 18 fishes or cut 9 pieces of wood per day, which means that for each wooden piece cut Timmy will forego catching 2 fishes. if we take this ratio of sacrifice we say that he can catch 9 fishes and 4.5 pieces of wood per day. If we sacrifice 1 more fish than Tummy can produce 0.5 more piece of wood. That becomes 8 fishes and 5 pieces of wood.The point (10,3) means that Timmy will catch 10 fishes and cut 3 pieces of wood per day. which will not be on the PPF. If from 9 units of fish he wants to consume 10, then he will forego 0.5 pieces of wood which will become 4. The exact point should be (10,4) and not (10,3).

2.

Required Reserves = 500*0.09 = 45 Billions

Excess Reserves = 5 Billions  

Total Reserves = 45+5 = 50 Billions

Loans = 1/RR * 450 = 1/0.09*450 = $5,000 Billion