Question

A goldsmith has \(\$ 2\) million of gold in his vaults. He issues S5 million in gold receipts. His gold holdings are what fraction of the paper money (gold receipts) he has issued? a. \(1 / 10\) b. \(1 / 5\) c. \(2 / 5\) d. \(5 / 5\)

Short answer

The gold holdings are \(\frac{2}{5}\) of the paper money issued, so the answer is c.

Step-by-step solution

Understand the Total Gold Receipts

The goldsmith has issued a total of \(5\) million dollars in gold receipts. This amount represents the total paper money that the goldsmith has issued.

Know the Gold Holdings

The actual gold held by the goldsmith in his vaults is \(2\) million dollars worth.

Calculate the Fraction of Gold Holdings

The fraction of gold holdings compared to the issued receipts is given by dividing the total value of gold holdings by the total value of gold receipts issued. This can be expressed as: \[ \text{Fraction} = \frac{\text{Gold Holdings}}{\text{Gold Receipts}} = \frac{2 \text{ million}}{5 \text{ million}}. \]

Simplify the Fraction

Simplify the fraction \( \frac{2}{5} \) to its simplest form. Since there are no common factors other than \(1\), the fraction \( \frac{2}{5} \) is already in its simplest form.

Choose the Correct Answer

Since the fraction of gold holdings to gold receipts is \( \frac{2}{5} \), the correct choice that represents this fraction is \( \frac{2}{5} \). This corresponds to option c.

Key concepts

Goldsmith Economics

In the past, goldsmiths played a crucial role in the development of modern banking systems. Initially, they were trusted individuals who stored gold for the wealthy. As they noticed a pattern– that not all gold was withdrawn at once– they began to issue receipts that could be used as a way of doing trade. This innovation led to a system where these gold receipts could circulate like money.

The term "Goldsmith Economics" refers to the historical practice where goldsmiths effectively created money by issuing more paper receipts than the actual gold in their vaults. This practice allowed the economy to benefit from increased money circulation without needing more gold. The crucial insight was the realization that as long as people trusted the value of the receipts, those receipts worked as money.

• Goldsmiths issued receipts as evidence of gold deposits.
• They allowed these receipts to be used for payments, much like modern-day banknotes.
• The practice evolved into the concept of fractional-reserve banking over time.

Money Supply

The term "money supply" encompasses the total amount of money available in an economy. This includes physical currency and various types of deposits that can be quickly converted into cash. Understanding money supply is vital because it influences economic conditions such as inflation, interest rates, and economic growth.

In the context of Goldsmith Economics, the money supply was essentially expanded by issuing more gold receipts than the mount of gold actually held. For example, our goldsmith kept $2 million worth of gold but issued $5 million in receipts. As a result, more money was circulating in the economy than was physically backed by gold.

• Money supply includes cash and equivalents like deposits.
• Expansion of money supply results from issuing more currency or equivalents than what is physically reserved.
• An increased money supply can stimulate economic activity but may also lead to inflation if unchecked.

Concept of Receipts

Gold receipts were the precursor to modern money and an essential part of early monetary systems. These receipts indicated a claim to a certain amount of gold held by a goldsmith. The concept was groundbreaking because it shifted the need for carrying heavy and cumbersome gold for transactions to paper certificates, which were far more convenient.

Initially, these receipts served merely as a documented acknowledgment of gold storage, but gradually they became a medium of exchange, akin to today’s banknotes. People began to trust the receipts so much that they were used as money for buying and selling goods, thus facilitating trade and commerce. Trust in the issuer was crucial, ensuring the receipts were accepted widely.

• Receipts acted as a pledge for the gold stored with a goldsmith.
• They represented an early form of promissory notes.
• The widespread acceptability of receipts helped pave the way for paper money.
• The ability to issue receipts beyond gold holdings foreshadowed fractional-reserve banking.