Wk 5 - The Asset Market, Money, and Prices Flashcards
Define money
Assets that are widely used and accepted as payment.
Medium of exchange
An object that is typically accepted in exchange for goods and services.
Unit of account
An agreed measure for stating the prices of goods and services.
Store of value
- Money can be stored for a period of time and later exchanged for goods and services.
- Money can be utilised to hold wealth.
- Most people use money only as a store of value for a short period and for small amounts because it earns less interest than money in the bank.
Commodity money
Valuable, easily standardised and divisible commodities (e.g. precious metals, cigarettes).
Fiat money
Paper money decreed by governments as legal tender.
Cheques
An instruction to your bank to transfer money from your account (not money).
Debit cards
Works like a paper cheque, only faster (not money).
Credit cards
A special type of ID card that gets you an instant loan (not money).
Stored-value card (smart card)
A physical card that has an embedded integrated chip that acts as a security token (not money).
EFTPOS
Debit card transaction system Electronic Funds Transfer at Point of Sale (not money).
E-Cash
An electronic equivalent of paper banknotes and coins, an electronic currency (money).
Bitcoin and cryptocurrencies
- Do not exist in physical form, only as a records in a computer system.
- Allows anonymous transactions.
M1 monetary aggregate
- Currency and traveller’s cheques held by the public.
- Transaction accounts on which cheques may be drawn.
- All components are used in making payments.
M2 monetary aggregate
Adds to M1 other assets that are not so liquid.
Uses of monetary policy
- Manage economic activity and achieve price stability.
- Fight unemployment and achieve full employment.
- Promote stable output growth and promote the general welfare of the people.
How does the central bank of a country increase and decrease the money supply?
Increase: Use newly printed money to buy financial assets from the public - an open-market purchase.
Decrease: Sell financial assets to the public to remove money from circulation - an open-market sale
Rate of return
An asset’s increase in value per unit of time.
Risk
- Degree of uncertainty.
- People prefer assets with low risk.
- Risk premium: the amount by which the expected return on a risky asset exceeds the return on an otherwise comparable safe asset.
Liquidity
- The ease and quickness with which an asset can be traded.
Time to maturity
- Amount of time until a financial security matures and the investor is repaid the principal.
Types of assets
- Money: low return, low risk and high liquidity.
- Bonds: higher return, more risk and less liquidity.
- Stocks: pay dividends and can have capital gains and losses, and are much more risky than money.
- Ownership of a small business: very risky and not liquid at all, but may pay a very high return.
- Housing: provides housing services and potential for capital gains, but is quite illiquid.
Demand for money
- Quantity of monetary assets people want to hold in their portfolios
- Depends on expected return, risk, and liquidity.
- Price level, real income and interest rates.
Price level
- Higher the price level, the more money you need for transactions.
Real income !!!
- Money demand rises as real income rises.
- Money demand isn’t proportional to real income as higher-income individuals use money more efficiently.
Interest rates
- Increase in interest rates or return on non-monetary assets decreases the demand for money.
- Increase in the interest rate on money increases money demand.
Other factors affecting money demand
- Wealth: rise in wealth may increase money demand, but not by much.
- Risk: increased riskiness in the economy may increase money demand.
- Liquidity of alternative assets: deregulation, competition, and innovation have given other assets more liquidity, reducing the demand for money.
- Payment technologies: credit cards, ATMs, and other financial innovations reduce money demand.
Elasticity of money demand
The percent change in money demand caused by a one percent change in some factor.
Income elasti ity of money demand
Positive: higher income increases money demand
Less than one; higher income increases money demand less than proportionately
Interest elasticity of money demand
Small and negative: higher interest rate on nonmonetary assets reduces money demand slightly.
Price elasticity of money demand
Unitary, which means money demand is proportional to the price level
Velocity
Measures how much money “turns over” each period
Quantity theory of money
Real money demand is proportional to real income.
