Module 8 Flashcards
Barter
To exchange goods or services for other goods or services without the use of money.
Double coincidence of wants
PROBLEM (barter): it takes time and resources for barter and trade to happen.
Commodity money
Is a good used as money, but also has an intrinsic value (e.g. gold).
Problem with commodity money
Difficult to control the supply of money (e.g. a new discovery) and to carry around.
Fiat money
Paper currency that is authorized by a central bank, but not backed by gold.
Problem with fiat money
Expectations: households and firms have confidence in the value of currency.
Medium of exchange
(Function #1): buyers and sellers are willing to accept it (legal tender).
Unit of account
(Function #2): a way of measuring value in the economy in terms of money.
ADVANTAGE: standardized money creates efficiency by valuing each good in dollars.
Store of value
(Function #3) A way to hold savings for future use.
Standard of deferred payment
It facilitates borrowing and lending over time.
DISADVANTAGE: Because of inflation, it loses purchasing power over time.
ADVANTAGE: It is easy to convert to a medium of exchange (liquidity)
Money is a stock
value of currency and value of deposits. Banks can create money by loaning out reserves in excess of the required reserves (RR).
Required Reserves
A bank is legally required to hold them, based on its deposits.
The simple deposit multiplier
1/RR
Change in checking account deposit.
= change in bank reserves * (1/RR)
Overall change in money supply
= increase in deposits - decline in currency
Open market operations (decided by the federal open market committee)
The trading desk purchases Treasury securities to increase the money supply: the sellers of securities deposit the funds -> increases loans -> increases reserves.
Discount policy
the reason for which the Federal Reserve was established.
Discount Rate
The interest rate the bank pays when borrowing from the fed.
The fed lowers the discount rate -> increases the money supply: banks borrow more -> increases reserves -> increases loans.
Lender of last resort
The Fed can act as a lender of last resort in case of a run on the banks (1930s).
Reserve Requirements (seldom changed by the Federal Reserve)
The Fed reduces the required reserves ratio -> increases the money supply: banks convert required reserves into excess reserves -> increases loans.
The money demand
Ceteris paribus, it shows the negative relationship between the interest rate (i) and the quantity of money (m) held by households and firms.
Why is the money demand curve negative
The negative slope results from the choice of households and firms holding money and holding treasury bills.
ADVANTAGE OF HOLDING MONEY: it can be used to buy goods and services (liquidity).
DISADVANTAGES OF HOLDING MONEY: it does not earn interests (opportunity cost).
Shifts in demand for money
An increase in real GDP (Y) -> The demand for money shifts right.
An increase in price level (P) -> The demand for money shifts right.
The equilibrium in the money market
Ms = Md: households and firms hold the desired amount of money given the equilibrium interest rate.
