A first look at the monetary system. Flashcards
Chapter 5
What is the definition of money?
The stock of assets that can be readily used to make transactions.
What are the three functions of money?
A medium of exchange, a store of value and a unit of account
What does it mean that money is a medium of exchange?
It means money is used to buy goods and services.
It replaces barter, making trade faster, easier, and more efficient.
This is one of the key functions of money — enabling transactions.
What does it mean that money is a store of value?
It means money holds its purchasing power over time.
You can save it now and use it later.
This function allows money to transfer value from the present into the future.
What does it mean that money is a unit of account?
It means money provides a common standard to measure prices and value.
Everyone uses it to compare the worth of goods, services, and assets.
This function makes economic calculation possible.
What is a barter economy?
An economy where goods are exchanged for goods
What is a monetary economy?
Money is used to buy goods and services
For a barter to occur what is needed to be satisfied?
For a barter to operate, the double coincidence of wants to be satisfied
Why is it a problem that “the price of each exchange is in a different unit”?
In a barter system, each good is priced in terms of another good (e.g. 1 chicken = 5 apples).
This makes it confusing and inefficient, as there’s no common way to measure value.
Every exchange has a different unit, so comparing prices is difficult.
✅ Money solves this by acting as a unit of account — a common standard for pricing everything.**
What type of economy does the double coincidence of wants occur and what is it?
The double coincidence of wants occurs in a barter economy, where two people must each want what the other is offering in order to trade.
How do you buy goods and services in a monetary economy?
Money is used to buy goods and services.
What is money used as in a monetary economy?
A medium of exchange and a unit of account
What does money as a medium of exchange mean?
A function of money that allows it to be used to buy goods and services.
It eliminates the need for a double coincidence of wants in a barter system.
Money is accepted by everyone in exchange for goods or services.
What is money as a unit of account mean?
A function of money that allows it to serve as a common standard for pricing goods and services.
It makes it easier to compare value, record debts, and measure profit — all prices are quoted in the same currency.
What units are goods and services in, in a monetary economy
Prices are all in the same unit
What is the difference between a barter economy and a monetary economy?
In a barter economy, goods are traded directly, requiring a double coincidence of wants and no common unit of value, each exchange has a different price unit.
In a monetary economy, money is used as a medium of exchange and a unit of account, making transactions and price comparisons much simpler and more efficient..
What are the 2 types of money?
Fiat money and Commodity money
What is Fiat money?
Money that has no intrinsic value: Paper currency.
What is commodity money?
Has intrinsic value: gold coins
Is the gold standard a form of commodity money or fiat money?
Commodity money — because it is backed by and exchangeable for gold, which has intrinsic value.
What are the reasons fiat money is accepted even though it has no intrinsic value?
Legal tender — must be accepted by law for payments and debts
Backed by government — used to pay taxes
Trusted by the public — people believe others will accept it
Widely accepted — works because everyone agrees to use it
What does it mean that fiat money is legal tender?
It means the law requires people to accept it as payment for debts and transactions.
This gives fiat money official status and helps ensure it is widely used.
How does government backing give fiat money value?
The government requires taxes to be paid in fiat money, creating demand.
Even without intrinsic value, people want it because it’s needed for legal obligations.
Why is trust important for fiat money?
People use fiat money because they trust that others will accept it too.
They also trust that the central bank will manage inflation and maintain its value.
Why is widespread use important for fiat money?
Fiat money works because it is universally accepted within a country.
Its usefulness comes from everyone agreeing to use it, even without intrinsic value.
What is the legal tender in England & Wales
Bank of England notes are legal tender.
They must be accepted for settling debts, but…
⚠️ Shops can still choose their own payment methods (e.g. card-only).
Are Scottish banknotes legal tender in England?
No — in Scotland, three private banks issue pound notes.
They are not legal tender in England, but many places may still accept them.
What is legal tender in most eurozone countries?
Euro banknotes must be accepted as a means of payment.
They are legal tender across all euro-using countries.
Are physical banknotes and coins considered money?
Yes — currency (like U.S. dollars or British pounds) is money.
It serves all three functions of money:
✅ Medium of exchange
✅ Store of value
✅ Unit of account
Are bank deposits in checking accounts considered money?
Yes — they are money because they also serve the three functions of money.
They are accessible for transactions and commonly used in the economy.
Are checks money?
No — a check is not money itself.
It’s just an instruction to a bank to transfer money.
But the funds in the account the check draws from are money.
Are debit cards considered money?
No — debit cards are not money, but a means of payment.
They instruct the bank to transfer money from your account.
The money itself is in the checking account.
Are credit cards considered money?
No — credit cards are not money.
They are a means of deferred payment, allowing you to borrow now and repay later.
You pay the credit card company later using money from your bank.
What is monetary policy?
Monetary policy is the use of interest rates and money supply by a country’s central bank (like the Bank of England) to influence economic activity.
What is the money supply?
The money supply is the total amount of money available in an economy at a given time.
It includes:
Currency (coins and notes held by the public)
Bank deposits (especially in checking/current accounts)
Other liquid assets (depending on how broadly money is defined — e.g. M1, M2, M3)
What are they money types included in the money supply?
Currency — coins and notes held by the public
Demand deposits — money in checking/current accounts
Savings deposits — easily accessible savings
Other liquid assets — like money market accounts (depends on how broad the measure is)
What is M1 in the money supply?
M1 = Currency + Demand Deposits
Most liquid form of money
Includes cash and money in checking/current accounts
Used for day-to-day transactions
What is M2 in the money supply?
M2 = M1 + Savings Deposits + Time Deposits
Less liquid than M1
Includes money that can be quickly converted into cash, like savings accounts
Still easily accessible, but not used directly for spending
What is M3 in the money supply?
M3 = M2 + Large Time Deposits + Other Financial Instruments
Broadest and least liquid definition
Includes large institutional deposits and long-term financial assets
Mostly used for analysing long-term money trends
What is M0 in the money supply?
M0 is the narrowest measure of money.
It includes:
Physical currency in circulation (notes and coins held by the public and banks)
Commercial banks’ reserves held at the central bank
Also called “base money” or “monetary base”
What is a savings deposit?
A savings deposit is money placed in a savings account at a bank or building society.
It earns interest and is usually meant for longer-term saving, not day-to-day spending.
Withdrawals may be limited or require notice.- M2
What are money market mutual fund balances?
Money Market Mutual Fund (MMMF) balances are funds invested in short-term, low-risk financial assets, like government bonds or commercial paper.
They are:
Highly liquid (can be quickly converted to cash)
Low-risk
Often used by firms and households as a short-term store of value
In the UK, are MMMFs part of M2 or M3?
In the UK, money market mutual fund balances are included in M4, which is broadly equivalent to M3 in other countries.
What are the main roles and responsibilities of central banks?
Control inflation
Stabilise growth
Maintain employment
Support financial stability
What is the main tool used by central banks to manage the economy?
Central banks manage a country’s monetary system and help ensure economic stability.
What does it mean that central banks are lenders of last resort?
It means that central banks will provide emergency loans to commercial banks or financial institutions that are facing a liquidity crisis (they’ve run out of cash but are not insolvent).
What is monetary control?
Monetary control refers to the actions taken by the central bank to regulate the money supply and control interest rates in the economy.
