Interesting Thought Question on Money Creation

[#1]

This is an example that I’ve adapted from an original story posted by Eric Keetch in the Financial Times on August 12, 2009 titled “Quantitative Easing: It’s So Simple!”

Suppose Will gives his wallet containing $100 to Alex to hold while he works out. During Will’s workout, Alex uses the $100 to pay his mechanic who fixed his scooter. The mechanic then took this $100 to his vet to pay off his past due account from services previously provided to his dog. The vet then used the $100 to pay Alex for money she owed him for tutoring her in economics. Alex then puts the $100 back into Will’s wallet. After Will’s workout, Alex returns the wallet to Will without him ever realizing that money was temporarily missing.

Although the same $100 was used without Will’s knowledge, everybody’s debt has been settled. How much money was created out of thin air?   

1. $300
2. $200
3. $100
4. $0

Answer: $300. Although the same $100 was used, the money was able to satisfy three separate $100 transactions. The same outcome would have happened if everyone: Alex, the mechanic, and the vet, each had their own $100 and used it to settle their debts. Instead, none of the three had any cash, but instead “borrowed” Will’s $100 and used it three times without him knowing.

[vazquj1234]

Really good exam, Eric!  I particularly like the multiple choice question, because for intro students it will be challenging enough to introduce the topic.  Many students would be tempted to choose (c). 

In fact, I think that is what I'm going to do next time I teach this concept.  I'm going to open up the class with the story, and then give the students the multiple choice problem as a clicker question.  Or, even better, I can assign the multiple choice question before class, and then use the student's answers from before class to start the discussion in class.

[vickyci]

Good example!