Economics Report: Elasticities, Bank Creation of Money, UGB 109

This report delves into key economic concepts, beginning with an explanation of three types of elasticities: price, income, and cross elasticity, including their calculations and applications. It then critically evaluates the usefulness of the concept of elasticities in various contexts, such as international trade, governmental policies, and decision-making by monopolists. The report further explores the role of commercial banks in money creation, discussing methods like providing loans, mortgage loans, and credit cards. It also examines the measures central banks employ to limit this ability, providing a comprehensive analysis of micro and macroeconomics factors. The assignment addresses questions from the UGB 109 Economics course, focusing on the interplay of market dynamics and financial institutions.

Economics

Table of Contents
Table of Contents.............................................................................................................................2
INTRODUCTION...........................................................................................................................1
QUESTION 1..................................................................................................................................1
a. Explanation of three different types of elasticities in economics and the way in which it
could be calculated......................................................................................................................1
b. Critical evaluation of the usefulness of the concept of elasticities..........................................3
QUESTION 3..................................................................................................................................4
a. Discussion of the way in which commercial banks create money...........................................4
b. Discussion of measure which are used by Central banks to limit this ability.........................5
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
Economics can be defined as the branch of knowledge which is highly concerned with
consumption, transfer and production of wealth. In other words, it could be defined as the
condition of a country in relation to material prosperity. Main purpose of it is to determine the
way in which all the limited resources are used by society (Andolfatto, 2018). It is a type of
social science which is utilised for the purpose of analysing the way in which funds are
employed by society to produce goods and services for consuming them in future. Present report
is based upon analysis of micro and macro economics factors so that knowledge about them
could be improved. The questions that are selected to answer in this assignment are one and
three. This report covers various topics such as types of elasticities, calculation of them and
critical evaluation of the usefulness of the concept of them. Apart from this, discussion of the
way in which commercial banks create money and measure used by central banks to limit this
ability are also covered in this project.
QUESTION 1
a. Explanation of three different types of elasticities in economics and the way in which it could
be calculated
Elasticity: It can be defined as the ability of an element to change and adapt
modifications in the environment. In economics, it is a type of measurement which is used to
determine the percentage change of one variable of economy in response to the changes in
another one. It is the degree of change to which producers, individuals or consumers change their
demand of the quantity of goods which is supplied by them. Main use of it is to determine the
alteration in the consumer demand in response to the changes in the price of goods or services. It
is an economic concept which is mainly used to determine the modifications in the quantity
demanded in the marketed in relation to the alteration of price of service or good demanded. An
item will be considered as elastic when the demand of it will change drastically when the price of
it will be inclined or declined (Bahaj and Reis, 2018). There are three main types of it which are
discussed below:
Types of elasticities: All the types of elasticities are described below:
 Price elasticity: It can be defined as the degree to desire of a good or services changes
because of alteration in its price. People’s desire for goods decreases because of the
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higher price of them. It is mainly used to determine the relation between changes in the
quantity demanded of a product and the price of it. It is analysed while analysing price
sensitivity in economics. With the help of it, the changes in demand because of increment
or decrement of price could be analysed (Price elasticity, 2015).
 Calculation of price elasticity: While calculating price elasticity of demand following
formula is implemented:
Percentage change in quantity demanded / percentage change in price of goods
With the help of it, elasticity in the price could be determined as all the changes in
demand and price are taken in to consideration which applying it.
 Income elasticity: This type of elasticity is used to measure the relationship between the
quantity demanded and consumer income. It is the sensitivity of the demand of a good to
the modification in the income of customers who buy it, keeping all the other elements
constant. Most of the business entities are using it to forecast the implication of the
business cycle upon the sales. With the help of it, responses of quantity demanded on the
changes in income could be determined.
 Calculation of income elasticity: While calculating income elasticity following formula
is implemented:
Percentage change in quantity demanded / percentage change in income of consumers
The above formula can help to analyse the income elasticity as demand as well as the
income level of customers is taken in to consideration in calculation (Barrdear and
Kumhof, 2016).
 Cross elasticity: This type of elasticity is used in economics to measure the responses of
changes in demand of one good to the change in price of another good. Main purpose of
it is to determine the impacts of changes in price of one good on the quantity demanded
on another good. All of them could be complementary or substitute products. With the
help of it interrelation between two different items is determined as the modification in
price of one of them will affect the demand of another one in the market.
 Calculation of cross elasticity: While calculating the cross elasticity following formula
is applied:
Percentage change in demand of one good / percentage change in the price of another good
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The above formulate can help to analyse the actual and accurate cross elasticity as it takes
change in price and quantity demanded to two different goods in to consideration while
calculation.
There are various types of elasticities which are described above. All of them are taken in
to consideration by business entities so that they can analyse the impact of them upon the sales in
upcoming period. While calculating them it is very important to use right formulas otherwise it
may result in inaccurate responses (Brown, 2019).
b. Critical evaluation of the usefulness of the concept of elasticities
In order to determine the prices of various factors of production it is very important to use
the concept of elasticities. Without them it will be very difficult for the business entities to
predict the implications of them upon their future sales. For example, if the demand of a product
in the market is inelastic then price of it will be very high and if it is elastic then the price will be
low. Therefore, in order determine the relationship between quantity demanded, price, income
etc, of one good and another good it is very important to be aware of the concept of elasticity. It
is very useful because it can help to formulate future decisions such as making changes in price
so that higher revenues could be generated (Chapman and Wilkins, 2018). The usefulness of this
concept could be analysed with the help of following discussion:
Strategizing international trade: Concept of elasticities is very useful while strategizing
the international trade. When an organisation is planning to fix prices for the products that will
be exported then it is very important to have detailed information of elasticity of demand of the
same. If a country is not having information of it then it may leave impact upon the foreign trade.
For example, a nation fixes higher price for the good which is inelastic in nature. On the other
hand, if the demand of an item is elastic in the importing country then the exporting one can set
lower price for the goods to be imported. It can help to generate higher revenues from foreign. It
is only possible if the economists are aware of the concept of elasticities (Deleidi, 2018).
Formulating governmental policies: For legal authorities the concept of elasticity is
also very important because with the help of it they can formulate different policies such as
taxation. The government can set higher taxes for the items that are having inelastic demand.
Apart from this, lower tax rates for the products that are having elastic demand could also be
imposed. It could be done by the legal authorities when they are highly aware of the concept of
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elasticity. If they are not having detailed information about them then it may result in
formulation of inappropriate strategies.
Decision making of monopolist: A monopolist seller always pay attention towards the
demand the produce before setting the prices. For example, if the nature of quantity demanded in
the market is elastic then lower prices will be imposed and in opposite situation it will be high.
The concept of elasticities is very useful for the sellers as they can formulate effective decisions
for their business which can help them to generate higher sales (Engert and Fung, 2017). If a
monopolist is not aware of the concept of elasticities then it will result in deciding wrong prices
for the products that can also leave unfavourable impact upon business.
Factor pricing: Concept of elasticities is useful while determining the price which is
required to be paid to the factors of production. The proportion of each and every factor in the
national product is analysed in relation to the demand. If the nature of the specific product is
inelastic as compared to the others then it may attract more rewards. In order to attain benefits, it
is very important to having proper information of concept of elasticities as it is very useful for
growth of business.
From the above discussion it has been determined that concept of elasticity is very
important and useful as it can help to formulate effective decisions for future. Lack of knowledge
of it may result in formulation of ineffective strategies that may leave unfavourable impact upon
the business.
QUESTION 3
a. Discussion of the way in which commercial banks create money
Commercial banks: These are the profit-making private organisations like other
businesses such as retail stores. All of them are operating business for the purpose of generating
higher profits so that they can sustain in the market and attain competitive advantage (Gümüsay,
Smets and Morris, 2020). These could be small or big and the main aim of them is to generate
high profits and increase revenues. There are various ways which are used by commercial banks
to create money. All of them are as follows:
Providing loans: It is one of the most common and main way which is focused by
commercial banks to make money. They offer different types of loans to individuals on specific
interest rates and earn from them. The rate which is charged by the banks on the loan is higher as
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compare to the rate of interest which is applied on the saving accounts and other deposits of the
customers. Commercial banks borrow money from central banks and pay them interest on the
same amount. This borrowed finance is used by them to provide loans to the customers so that
they can make money. These loans are personal loans, vehicle loans etc.
Mortgage loans: It is another way which is used by commercial banks to generate
money. When an individual buys a home and take a home loan then the duration of it will be 10
to 20 or 30 years. The amount of it is very high and the rate of interest is fixed. It is one of the
major ways which is used by commercial banks to create money. The interest which is charged
by bank on the home loan for the long duration is the income of the bank. It is long-term source
of income for a bank which is used by it.
Credit cards: It is also a mode of creating money which us focused by commercial
banks. By using it they offer credit cards to the customers and allow them to make payment after
a fixed period by charging a specific rate of interest. It is a type of way which could be used by
individuals to save their savings as with the help of it they can spend money without debiting
their saving account. It is a mode which is very beneficial for the bank because when a person
fails to make payment of the credit card then the interest which is charged on it is very high. In
difficulties individuals also borrow money on the credit card which also charge a higher rate of
interest. All the interest which is charged by the commercial banks on the amount is their income
(Khemraj, 2018).
All the above described ways are focused by banks to generate money. With the help of
all of them commercial banks try to create huge monetary resources so that they can achieve
competitive advantage in the industry and perform operational activities in systematic manner.
There is one similarity in all these ways which is interest charged by bank on the amount which
is lend by them to the clients.
b. Discussion of measure which are used by Central banks to limit this ability
There are various types of measures that are used by Central Bank to limit the ability of
commercial banks to create cash. All of them are as follows:
Controlling credit by making variations in the bank rate: It is one of the main
measures which is focused by central bank to control the ability of commercial banks to generate
money. Central bank controls the credit by making variation in bank rates. All the banks rates are
changed and imposed by the central bank. The credit which is used by banks to generate interest
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from its customers is controlled by central bank. When a bank is providing a very large number
of loans to the clients then central bank make sure that it changes the bank rate so that the ability
of banks to create money could be controlled. If it will be changed by central bank the
commercial banks will be required to formulate new policies according to it so that operations
could be carried out systematically. If banks will not lend money according to the modified bank
rate of central bank then strict actions against it could be taken which may affect the
sustainability and market image. In order to ignore such situations, the commercial banks are
required to make changes in its policies accordingly (Kurtzman and Zeke, 2020).
Formulating monetary policy: Central bank formulates monetary policy for the whole
nation so that the flow of finance could be controlled by it. For the smooth and proper flow of
funds in the market monetary policy is formulated by central banks of different countries. It also
targets inflation so that the stability of the economy could be maintained. Main aim for the
formulation of it is to control the ability of commercial banks to create money by controlling
interest rate which is charged by them on the loans that are provided to the clients. When central
banks analyses that a bank is charging a very high interest rate from the clients on different loans
then monetary policy is modified by it. After modifications the central banks of the countries
make sure that the interest rate which is charged by banks from the customers is reduced. All the
banks have to make alteration in their policies according to it. If they are not able to make
changes then it may leave negative impact upon the economy and to control this situation central
bank make sure that all the banks comply with all the new policies. Monetary policy is the basis
of the measures which are used by central bank to control the ability of commercial banks to
generate monetary resources from the market.
Controlling repo and reverse report rate: All the commercial banks take loan from the
central bank and the interest rate which is charged by the central bank is known as repo rate.
After the duration of the loan the bank pays the loan amount to the central bank and the interest
rate which at which commercial banks provide funds to the central banks is known as reverse
report rate. Both of them are controlled and formulated by central bank. Repo rate is always
higher than the reverse repo rate (Wullweber, 2020). It shows that the commercial banks will
also have to pay a higher rate to the central bank if any loan is taken from it. When one of them
is charging a higher rate from the customers then central bank changes the repo rate so that the
funds of commercial banks could be controlled.
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From the above discussion it has been determined that there are various measures which
are used by central bank to control the ability of commercial banks to generate cash. If these are
not focused by the banks then it may result in strict legal actions against them that may leave
negative impact upon their market image.
CONCLUSION
From the above project report, it has been concluded that economics is the branch of
knowledge which is highly focused with transfer and consumption of monetary resources. In
order to bring smoothness in the economy of a country it is very important for the economists to
have detailed information of elasticities. There are three different types of it which are price,
income and cross elasticity. All of them are very useful for the businesses as well as the
governmental bodies. Some of the significance of them are strategizing international trade,
formulating governmental policies, decision making of monopolist and factor pricing. There are
various types of ways which are focused by commercial banks to generate money. These are
providing loans, mortgage loan and credit card. The interest which is charged on all of them is
the main source of income for the banks. There are various types of measures which are used by
central banks to control the ability of commercial banks to create money. These are controlling
credit by making variations in the bank rate, formulating monetary policy, controlling repo and
reverse report rate etc. All these ways are adopted by the central bank to make sure that it
controls the ability of commercial banks to create money and perform operations.
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REFERENCES
Books and Journals:
Andolfatto, D., 2018. Assessing the impact of central bank digital currency on private
banks. FRB St. Louis Working Paper, (2018-25).
Bahaj, S. and Reis, R., 2018. Central bank swap lines.
Barrdear, J. and Kumhof, M., 2016. The macroeconomics of central bank issued digital
currencies.
Brown, W. B., 2019. Keeping the Central Bank Central: US Monetary Policy and the Banking
System. Routledge.
Chapman, J. and Wilkins, C. A., 2018. Crypto" money": Perspective of a couple of Canadian
central bankers (No. 2019-1). Bank of Canada Staff Discussion Paper.
Deleidi, M., 2018. Post Keynesian endogenous money theory: A theoretical and empirical
investigation of the credit demand schedule. Journal of Post Keynesian Economics.
41(2). pp.185-209.
Engert, W. and Fung, B. S. C., 2017. Central bank digital currency: Motivations and
implications (No. 2017-16). Bank of Canada Staff Discussion Paper.
Gümüsay, A. A., Smets, M. and Morris, T., 2020. “God at work”: Engaging central and
incompatible institutional logics through elastic hybridity. Academy of Management
Journal. 63(1). pp.124-154.
Khemraj, T., 2018. Monetary policy and excess liquid assets in small open developing
economies. Handbook of Small States: Economic, Social and Environmental Issues. p.9.
Kurtzman, R. and Zeke, D., 2020. Misallocation costs of digging deeper into the central bank
toolkit. Review of Economic Dynamics.
Wullweber, J., 2020. The Politics of Shadow Money: Security Structures, Money Creation and
Unconventional Central Banking. New Political Economy. pp.1-17.
Online
Price elasticity. 2015. [Online]. Available through:
<https://blog.blackcurve.com/what-is-price-elasticity>
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