Question

Suppose that a small country currently has \(\$ 4\) million of currency in circulation, \(\$ 6\) million of checkable deposits, \(\$ 200\) million of savings deposits, \(\$ 40\) million of small-denominated time deposits, and \(\$ 30\) million of money market mutual fund deposits. From these numbers we see that this small country's \(M_{1}\) money supply is _________, while its \(M_{2}\) money supply is _________. a. \(\$10\) million; \(\$280\) million. b. \(\$ 10\) million; \(\$ 270\) million. c. \(\$ 210\) million; \(\$ 280\) million. d. \(\$ 250\) million; \(\$ 270\) million.

Short answer

a. \(\$10\) million; \(\$280\) million.

Step-by-step solution

Understanding M1 Components

M1 includes the most liquid forms of money. In this case, M1 is made up of two main components: currency in circulation and checkable deposits. In this problem:\[ \text{M1} = \text{Currency in circulation} + \text{Checkable deposits} = \\(4\, \text{million} + \\)6\, \text{million} = \$10\, \text{million}. \]

Calculating M2 Money Supply

M2 includes everything in M1 plus additional components that are not as liquid but still easily accessible. Those are savings deposits, small-denominated time deposits, and money market mutual fund deposits. Thus,\[\text{M2} = \text{M1} + \text{Savings deposits} + \text{Small time deposits} + \text{Money market funds}. \]Substitute the given values:\[ \text{M2} = \\(10\, \text{million} + \\)200\, \text{million} + \\(40\, \text{million} + \\)30\, \text{million} = \$280\, \text{million}. \]

Choosing the Correct Answer

From the calculations, we found that the M1 money supply is \\(10 million and the M2 money supply is \\)280 million. Thus, the correct answer to the problem is:- \(\text{a. } \\(10\, \text{million}; \\)280\, \text{million}\).

Key concepts

M1 Money Supply

The M1 money supply is an important economic indicator that represents the most liquid forms of money in a country. It includes two primary elements:

• Currency in Circulation
• Checkable Deposits

These components are the easiest forms of money to spend. They are readily available for transactions. In this case, our small country has \(4\) million dollars in currency in circulation and \(6\) million dollars in checkable deposits. By adding these two figures, we find that the M1 money supply is \(4 + 6 = 10\) million dollars. This tells us how much money is immediately accessible to the public for spending. This indicator is essential for understanding how much active cash flow exists in the economy at any given time.

M2 Money Supply

M2 is a broader measure of the money supply that includes all the M1 components but also considers other types of deposits that are a step less liquid. These components include:

• Savings Deposits
• Small-denominated Time Deposits
• Money Market Mutual Funds

While these are not as easily accessible as cash or checkable deposits, they can still be quickly converted to M1 components without much hassle. For instance, our exercise indicates that this country has \(200\) million in savings deposits, \(40\) million in small time deposits, and \(30\) million in money market funds. To find M2, we add these to M1: \[M2 = 10 + 200 + 40 + 30 = 280 \]million dollars. This measure provides a broader view of money available in the economy, both liquid and near-liquid, for spending or investments.

Currency in Circulation

Currency in circulation refers to the physical money—coins and paper bills—that are used in transactions among people and businesses. This is a key part of the M1 money supply. In our example, the country has \(4\) million dollars out there being used for buying goods and services. It's the most accessible form of money because anyone can use it immediately without the need for a bank or electronic transaction. This accessibility makes it the cornerstone of everyday purchases and economic exchanges. Understanding the amount of currency in circulation is crucial because it gives insight into the buying power people have at their direct disposal.

Checkable Deposits

Checkable deposits are another crucial part of the M1 money supply, offering immediate liquidity similar to cash. These deposits are funds in your checking account that you can access quickly by writing a check or using your debit card. In the exercise, the country has \(6\) million dollars in checkable deposits. Although these funds are electronic compared to physical currency, they are just as accessible for purchase transactions. Checkable deposits feature prominently in the economy because they facilitate easy and secure financial transactions, helping bridge the gap between cash and electronic funds. Many people rely on checkable deposits for everyday expenses, making them a clear part of immediate financial liquidity.