Question

Question 1

a) Let’s assume that upon graduation, you are deciding between two job offers in different cities (i.e. Terra and Smallville) in a hypothetical country, Wakanda. The job offer in Terra pays a salary of $50,000 per year, while the Smallville job offer pays a salary of $40,000 per year. The Consumer Price Index (CPI) in Terra is 150, and the CPI in Smallville is 90.

1. Calculate the Terra salary in Smallville dollars and Smallville salary in Terra dollars. Workings has to be shown.                                                  

2. Which offer should you take up? Explain your decision.                           

b) The Central Bank of Country X has recently announced that the statutory reserve requirement is 20%. If the Central Bank decides to increase money supply by $40 million, analyse and explain how the Central Bank can accomplish this goal.                     

Answer 1

a) Job in Terra pays = $50,000

Job in Smallville pays = $40,000

CPI in Terra = 150

CPI in Smallville = 90

i) Terra salary in Smallville dollar = [50,000 * (150 / 90)] = 83,333.33

Smallville salary in Terra dollar = [40,000 * (90 / 150)] = 24,000

ii) I will go to Smallville where nominal income is less while real income is much more than Terra.

b) Reserve requirement = 20%

Target to increase in Money supply = $40 million

Multiplier = (1 / Reserve requirement) = (1 / 0.2) = 5

Target to increase in money supply = Rise in money supply * Multiplier

$40 million = Rise in money supply * 5

Rise in money supply = $8 million

A new deposit of $8 million will raise money supply by $40 million.