Case study: Active Learning Instruments for Teaching Under-graduate Economics Concepts

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Experiment #3: Learning Activities to Assist Understanding of Changes in the Money Supply

This activity gives students an understanding of the causes of changes in the money supply in an economy. The activity is divided into two parts:

  1. the primary change in the money supply where students identify the players and activities in an economy that causes a primary change in the money supply and those that does not.
  2. the secondary change in the money supply that follows the primary change. The aim of this activity is to show the process of the credit multiplier that occurs when this new money ($200) flows into the banking system.

Primary change in the money supply

  1. The class is divided into groups of five players. Each person in the group takes one of the roles listed below.
    • Central Bank also includes the tax department, which collects tax for the Government. The tax is credited to the Government account at the Central Bank.
    • Construction Firm
    • Supermarket
    • Construction employees
    • Supermarket employees
  2. A “Central Bank” labelled large box, into or out of which money flows, represents the Central Bank. The Central Bank has a supply of money = $1,000. This money is in notes of $10 x 50, $50 x 8 and $100 x 1 printed in different colours. The Central Bank is the only holder of money ($1,000). Other players have no money at the beginning of this activity. Interaction of the Government and its agencies with members of the public cause money to flow into or out of the Central Bank.
  3. The tutor, who starts the activity, plays the role of Government.
  4. A series of situations is set out on a worksheet, which is given to students. Figure 2 presents the Worksheet #1 (Appendix 1). For each situation:
    1. the relevant players exchange money as the activity is described;
    2. each student records on the worksheet the primary change in the money supply and the amount of the change,
    3. at the end of the exercise students complete the diagrammatic summary to illustrate the movement of money into and out of the Central Bank and the effect on the primary change in the money supply.

At the end of this activity, students should be able to discover that:

  1. there is a primary increase of $200 in the money supply;
  2. students should discover that primary changes in the money supply occur as a result of actions of the Government, its agencies and the Central Bank; and
  3. monetary transactions between different members of the public do not cause a primary change in the money supply

Secondary change in the money supply

Assumptions made are:

  • There is one Registered Bank (RB);
  • There are no withdrawals from the money flow i.e. all money loaned by the RB is returned to it as deposits;
  • The RB always returns to a fully loaned up position;
  • There is no change in a required reserve ratio.
  1. This is an individual exercise. Four worksheets, each with a required reserve ratio (R) for the RB, are handed out to students at random. Figure 3 presents Worksheet #2 (Appendix 1). Each student receives one worksheet, which is likely to be different from his/her neighbor. The required reserve ratios used are R= 0.1, R = 0.2, R = 0.25 and R = 0.5. The worksheet is divided into three columns – deposit, loan, and reserves.
  2. Students use the prudential ratio given and the primary change ($200 increase) in the money supply to calculate the step by step process of the secondary increase in the money supply as the registered bank lends money to the public. Each step is entered on the worksheet by the student when he/she fills in details in the three columns provided – deposit, loan and reserves. At the end of this exercise, each column on the worksheet is totaled.
  3. Students are asked to calculate the credit multiplier from the required reserve ratio provided and the primary change, the secondary change, and the total change in the money supply. Students enter the totals in the spaces provided on the worksheet. To make a comparison of the two totals of each column (deposit, loan, and reserves) on the worksheet provided.
  1. Students compare results of the different required reserve ratios on the secondary change in the money supply. The smaller the prudential ratio the larger the effect on the secondary increases in the money supply and vice versa.
  2. Students discuss the implications of the resulting secondary changes in the money supply on the economy – effects on interest rates, inflation, GDP.

Extension Exercises

  1. Students construct a balance sheet of the RB to illustrate the changes that have taken place as a result of the injection of new money into the banking system under the different required reserve ratios.
  2. Students discuss the implications of the resulting secondary changes in the money supply on exchange rates given perfect capital mobility.
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