Answer to Question 1
A free lunch means that there is no tradeoff, that is, the production of one good or service can be increased without decreasing the production of another good or service and thereby giving up some of the other good. A free lunch occurs when the economy is producing at a point within the production possibilities frontier because at these points some resource is unemployed. By utilizing the unemployed resource, more goods or services can be produced without giving up any other goods or services.
Answer to Question 2
If the currency drain is zero so that all money created is deposited in bank accounts, the money multiplier is equal to one divided by the desired reserve ratio. If the currency drain is positive, then some newly created money is held in cash and is not deposited in bank accounts. In this case, the money multiplier is smaller so that a change in the monetary base leads to a smaller change in the quantity of money.
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Consider the production function ( ) 0.5 0.5 Y = AK L . Suppose both saving rate (s) and the ...
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