Question

6a. CPI Data for a basket of goods for Kings Landing Year 1 (Year of Summer) Swords 150 units $300 Each Firewood 1000 units $2 Each Food 2000 units $1 Each Year 2 (Year of Winter) 90 units $200 Each 5000 units $_ Each 900 units $2 Each If I told you that there was 15% inflation between year 1 and year 2, what must be the price for Firewood in year 2? 6b. A Fictional Country's Central Bank injects 225 Billion dollars into the banking system leading to a growth of M1 of 900 Billion dollars. What is the required reserve ratio of the country?

Answer 1

6(a)

Price of firewood in Year 1 = $2

Inflation = 15%

This means that price has increased by 15%.

Increase in price = $2 * 0.15 = $0.30

Price of firewood in Year 2 = Price of firewood in Year 1 + increase in price of firewood = $2 + $0.30 = $2.30

Thus,

The price of firewood in Year 2 must be $2.30 each.

6(b)

Initial increase in reserves = $225 billion

Total increase in money supply = $900 billion

Calculate the money multiplier -

Money multiplier = Total increase in money supply/Initial increase in reserves = $900 billion/$225 billion = 4

The money multiplier is 4.

Calculate the required reserve ratio -

Required reserve ratio = 1/Money multiplier = 1/4 = 0.25 or 25%

Thus,

The required reserve ratio is 25 percent.