Question

Q1: What would happen to the general price level when goldsmiths start lending out the gold coins which their customers had deposited with them. Explain your reasoning. Assume that the size of the economy remains the same. Note also that the paper certificates of gold issued by the goldsmiths when they accepted their customers' deposits remain in circulation.

Q2: What will happen to the general price level when the price of gasoline goes up while the size of the economy and the money supply remain unchanged. You don't need to discuss why the economy is not shrinking. Just accept that the size of the economy remains the same.

Answer 1

1. When the goldsmith starts lending the gold coin to the people who deposited them to the goldsmith, then the general price level starts increasing. In the high vitality period, the domestic market is touching the high gold price. As gold loan is a better option for small and large businesses to fulfill immediate need, the demand for gold rises. If the economy remains the same, the demand for gold increases which leads to raise in general prices.

Gold prices are increasing and so is the demand for gold loans. When the value of gold rises, it helps the customer to raise better loan money. There has been a lot of demand of gold from the shopkeepers, small businesses, start-ups industries etc. which uses the gold loan for starting the operations and for smooth working of the organization. Gold is the prevailing medium of exchange.

The people give their gold to the goldsmith to store and the goldsmith issues them a paper receipt. People further use these receipts to redeem the gold from the goldsmith when they need to make purchase. Now there are some depositors who trade their gold receipt instead of going back to the goldsmith. In this way this paper receipts circulates in the economy.

2. When the gasoline prices rises, the general price level of the economy also increases. Gasoline plays an important role in transportation, travelling, jobs, etc. which affects the households directly. When the prices of gasoline increases, it leads to more expense on transportation by general public, workers, shopkeepers etc. this will reduce the income of the people. Also, gasoline is an important input for transportation and high price of gasoline will also make the transportation cost much higher. Therefore, the general price level of the economy increases.