The Role of Money in an Economy Flashcards
What is the definition of money?
Money is a widely accepted medium of exchange that facilitates transactions.
What are the inefficiencies of a barter economy?
Barter economies are inefficient due to fundamental economic frictions, which limit market expansion, inhibit specialization, and suppress economic dynamism.
What is the double coincidence of wants?
Both parties must simultaneously desire what the other offers.
How does the double coincidence of wants affect trade?
It reduces the probability of successful trades, leading to substantial transaction costs.
What is one consequence of the double coincidence of wants?
It suppresses trade volume and discourages market specialization.
What is the issue of lack of divisibility in a barter economy?
Many goods do not lend themselves to precise fractional exchanges.
What creates transactional rigidities in a barter economy?
The indivisibility of certain products, like livestock or tools.
What are the two strategies parties must use in a barter economy due to lack of divisibility?
- Engage in roundabout trades
- Accept inequitable trades
What is a significant limitation of barter economies regarding value?
Difficulty in storing value.
Why is an effective store of value essential for trade?
It enables intertemporal trade, where individuals postpone consumption to accumulate capital.
What limitation do barter economies face with perishable goods?
Severe constraints in value storage.
How does the difficulty in storing value impact an economy?
It limits capital formation and reduces the economy’s ability to smooth consumption over time.
What is the main reason for the emergence of money?
Response to inefficiencies in barter-based exchange
Barter systems often faced challenges such as indivisibility and lack of standardization.
What type of money was initially adopted by societies before metallic money?
Commodity money
Examples include cattle in Mesopotamia and cowrie shells in Africa and Asia.
Who were among the first to mint coins and around what time?
The Lydians around 600 BCE
They minted coins from electrum, an alloy of gold and silver.
What problem did coins solve in economic transactions?
Indivisibility problem
Coins allowed for transactions of varying values without the limitations of barter.
List three advantages of coins as a form of money.
- Standardized measure of value
- Durability as a store of wealth
- Divisibility into smaller denominations
What role did states and empires play in the regulation of metallic money?
Critical role in its regulation
States institutionalized coinage and set standards for currency.
How did the Roman Empire contribute to the use of coins?
Institutionalized coinage for taxation, market integration, and legal tender enforcement
This facilitated efficient tax collection and long-distance trade.
Fill in the blank: The use of a common currency across vast territories enabled _______.
[long-distance trade and economic expansion]
True or False: The Roman Empire did not enforce the acceptability of certain coins.
False
Governments enforced the use of certain coins to increase confidence in their value.
What role does money play in price-setting?
Money provides a common unit of account, allowing for price-setting and the development of financial instruments such as credit and debt.
How does Adam Smith’s concept of the division of labor relate to productivity?
The division of labor increases productivity by allowing individuals and firms to focus on tasks in which they have a comparative advantage.
What are dynamic efficiency gains?
Dynamic efficiency gains refer to increasing returns to scale that occur as markets expand and specialization deepens.
What is the significance of money in the process of specialization?
Money allows specialization to deepen over time, unlocking productivity improvements that drive long-term economic growth.
What does capital accumulation enable in an economy?
Capital accumulation enables the development of capital markets and allows businesses to finance expansion beyond their immediate cash reserves.
How does money contribute to capital formation?
Money serves as a means of deferred payment, facilitating the development of credit markets essential for productivity improvements and technological progress.
What is the impact of high transaction costs on an economy?
High transaction costs discourage exchange, leading to market failures.
Who formalized the concept of transaction costs?
Ronald Coase formalized the concept of transaction costs in 1937.
How does money reduce transaction costs?
Money standardizes value through a common unit of account, reducing informational asymmetries and simplifying pricing.
What are the effects of reducing transaction costs on markets?
Reducing transaction costs leads to more transparent and efficient markets.
Fill in the blank: Money plays an integral role in the _______ process that allows specialization to deepen over time.
[self-reinforcing]
What type of money was historically relied upon before fiat money?
Commodity money
Commodity money is backed by tangible assets such as gold or silver.
What system provided monetary stability by linking national currencies to a fixed quantity of gold?
The Gold Standard
The Gold Standard was formalized under the Bretton Woods system in 1944.
What was a major limitation of the Gold Standard?
It constrained excessive monetary expansion
Central banks could not issue more currency than their gold reserves allowed.
What event marked the transition from the Gold Standard to a fiat monetary system?
The collapse of Bretton Woods in 1971
This event shifted the basis of money from being asset-backed to government decree.
What is fiat money?
Money that derives its value from government decree and public confidence
Fiat money is not backed by a physical commodity.
What is a vulnerability of fiat monetary systems?
Inflationary pressures
Governments and central banks can expand the money supply without direct constraints.
What significant development in currency occurred in the 21st century?
The emergence of digital currencies and cryptocurrencies
This introduced a paradigm shift in the conception of money.
What cryptocurrency, launched in 2009, exemplifies a decentralized alternative to fiat money?
Bitcoin
Bitcoin operates outside traditional banking systems.
What are Central Bank Digital Currencies (CBDCs)?
Digital versions of fiat money that retain regulatory control by governments
CBDCs are a response to the rise of cryptocurrencies.
What is a core function of money that can be undermined by high inflation?
Acting as a store of value
This function is compromised during periods of hyperinflation.
What historical examples illustrate the risks of monetary mismanagement?
Hyperinflation in Weimar Germany (1923) and Zimbabwe (2000s)
Excessive money supply growth in these cases led to economic collapse.
