chapter 3: What is Money ? Flashcards
Meaning of Money
- economists define the word “Money” (+examples)
(or the “money supply”): anything that is generally accepted as payment for goods or services or in the repayment of debts.
- Currency (paper money and coins): only one type of money
- Checks, saving deposits, … whenever it can easily be converted into currency
• Wealth:
the total collection of pieces of property that serve to store value (not just money, also bonds, common stocks, land, houses, cars, furniture, art,…)
• Income:
flow of earnings per unit of time (a flow concept)
a rather broad definition of what is money
- anything that is generally accepted as payment for goods and services or in the repayment of debts
- a certain amount at a certain point in time (a stock concept)
Functions of money
- Medium of Exchange
- Unit of Account
- Store of Value
Medium of Exchange
Used to pay for goods and services
The use of money as a medium of exchange promotes economic efficiency by minimizing the time spent in exchanging goods and services:
- Eliminates the trouble of finding a double coincidence of needs (reduces transaction costs – time spent to try to exchange goods or services)
- Promotes efficiency by allowing specialization in what people do best
Medium of Exchange
• Criteria that need to be met:
- be easily standardized (to ascertain value)
- be widely accepted
- be divisible (to make change)
- be easy to carry
- not deteriorate quickly
Unit of Account
•Used to measure value in the economy
- Compare with barter – introduction of money allows you to quote prices in terms of units of that money
• Reduces transaction costs
- Reducing the number of prices that need to be considere
Liquidity
- Relative ease and speed with which an asset can beconverted into a medium of exchange
- Highly desirable
- Money is the most liquid asset because it is the medium of exchange – no conversion is necessary, therefore no transaction costs
Store of Value
Remarks:
- liquidity
- Quality of the store of value depends on the price level
Why quality of the store of value depends on the price level
- Inflation versus Hyperinflation (period of extreme inflation)
- When price level increases rapidly, money loses value fast and people become reluctant to hold wealth in this form
Payment system:
the method of conducting transactions in the
economy
Evolution of the Payments System
- Commodity Money
- Fiat Money
- Checks
- Electronic Payment
- E-Money
Commodity Money
• Money needs to be universally acceptable – object that has value to everyone is a clear candidate
• Valuable, easily standardized and divisible
commodities (e.g. precious metals, cigarettes)
•Heavy… (gold coins)
Fiat Money
- Paper money (pieces of paper that function as a medium of exchange) decreed by governments as legal tender, not convertible in coins or precious metal
- Lighter but need for trust, and counterfeiting needs to be difficult
- Still: easily stolen, expensive to transport
Checks
• An instruction to your bank to transfer money from your account
pro:
- No need to carry around large amounts of currency
- Improved the efficiency of the payments system
- Payments can be cancelled out and reduces transportation costs, improves the economic efficiency
- Easier for larger transaction
- Loss from theft greatly reduced
Electronic Payment
e.g. online bill pay
• Webbanking
• Recurring bills can automatically be deducted from your account.
• Important cost savings
Electronic Money – E-Money
Money that exists only in electronic form
• Debit card:
• Stored-value card
• E-cash:
Debit card:
enable consumers to buy goods and services by
electronically transferring funds directly form their bank account to a merchant’s account.
• E-cash:
setting up an account that has links to the internet and transfers the e-cash to the computer
Stored-value card
Examples:
- Bought for a present amount that the consumer pays up front (example: Proton – comparable to a prepaid phone card)
- Card containing a chip that can be loaded with digital cash from the owner’s bank account when needed (smart card) – eg pay by phone
currency
- commodity money
- > INTRINSIC VALUE of the product (gold)
- fiat money= fiduciary money
- > TRUST !
- > is decreed by the government
- local money/ alternative money
- > not based on intrinsic value (IV)
- > not decreed by the government
- > accepted on a voluntary basis
what is the demand to be the most liquid form of Money, the Motives:
• Number of transactions - positive
• Precautionary: against uncertain future
• Speculative:
- The real rate of money holdings (positive)
- The opportunity cost (return of substitutes: negative)
- The risk to lose value (positive)
The Fed
The Federal Reserve’s Monetary
Aggregates : central banking authority responsible for the monetary policy in the US)
