Chapter 3 What Is Money? 20-1 © 2016 Pearson Education Ltd. All rights reserved. Preview • In this chapter, we develop precise definitions by exploring the functions of money. • looking at why and how it promotes economic efficiency. • tracing how its forms have evolved over time, and examining how money is currently measured. 1-2 © 2016 Pearson Education Ltd. All rights reserved. Learning Objectives • Describe what is money • List and summarize the functions of money • Identify different types of payment systems • Compare and contrast the M1 and M2 money supplies 1-3 © 2016 Pearson Education Ltd. All rights reserved. Meaning of Money • Money (or the “money supply”): anything that is generally accepted as payment for goods or services or in the repayment of debts. • To define money merely as currency is much too narrow a definition for economists ,Because • checks are also accepted as payment for purchases, checking account- deposits 1-4 © 2016 Pearson Education Ltd. All rights reserved. MEANING OF MONEY • savings deposits, can, in effect, function as money if they can be quickly and easily converted into currency or checking account deposits. • As you can see, no single definition of money or the money supply is possible, even for economists. 1-5 © 2016 Pearson Education Ltd. All rights reserved. Meaning of Money • What is the different between money , Income and wealth ? • Money (a stock concept) is different from: – Wealth: the total collection of pieces of property that serve to store value – Income: flow of earnings per unit of time (a flow concept) 1-6 © 2016 Pearson Education Ltd. All rights reserved. 2- Functions of Money A. Medium of Exchange: • it is 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. money as Medium of Exchange can : – reduces transaction costs – Promotes specialization 1-7 © 2016 Pearson Education Ltd. All rights reserved. Functions of Money • A medium of exchange must: – – – – – 1-8 be easily standardized be widely accepted be divisible be easy to carry not quickly damaged © 2016 Pearson Education Ltd. All rights reserved. Functions of Money B- Unit of Account: that is, money is used to measure value in an economy. We measure the value of goods and services in terms of money, just as we measure weight in terms of pounds or distance in terms of miles. • Money as unit of Account – Used to measure value in the economy – Reduces transaction costs 1-9 © 2016 Pearson Education Ltd. All rights reserved. Functions of Money • C- Store of Value: This function of money is useful because most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until we have the time or the desire to shop. • Money is not only a store of value; any asset— whether money, stocks, bonds, land, houses, art, can be used to store value . • But money is more liquid compere with other asset 1-10 © 2016 Pearson Education Ltd. All rights reserved. Functions of Money oMoney also functions as a store of value – Used to save purchasing power over time – Other assets also serve this function. – Money is the most liquid of all assets but loses value during inflation. 1-11 © 2016 Pearson Education Ltd. All rights reserved. Money loses value during hyperinflation. For Example: • Hyperinflation occurred in Germany after World War I, with inflation rates sometimes more 1,000% per month. • By the end of the hyperinflation of 1923, the price level had risen to more than 30 billion times what it had been just two years before 1-12 © 2016 Pearson Education Ltd. All rights reserved. 3- Evolution of the Payments System • The payments system has been evolving over centuries, and with it the form of money. At one point, precious metals such as gold were used as the principal means of payment and were the main form of money. • Later, paper assets such as checks and currency began to be used in the payments system as money • Where the payments system is heading has an important bearing on how money will be defined in the future. 1-13 © 2016 Pearson Education Ltd. All rights reserved. Evolution of the Payments System types of payment: • Commodity Money: valuable, easily standardized and divisible commodities (e.g. precious metals, cigarettes) • Fiat Money: the next development in the payment system was paper money decreed by governments as legal tender • Major drawbacks of paper currency and coins are that they are easily stolen and can be expensive to transport in large amounts 1-14 © 2016 Pearson Education Ltd. All rights reserved. Evolution of the Payments System • Checks: an instruction to your bank to transfer money from your account • Not need to carry large amounts of currency • reduces the transportation costs • that they can be written for any amount up to the balance in the account . 1-15 © 2016 Pearson Education Ltd. All rights reserved. Evolution of the Payments System • Electronic Payment : The development of inexpensive computers and the spread of the Internet now make it cheap to pay bills electronically. • Not only do you save the cost of the stamp, but paying bills becomes (almost) a pleasure requiring little effort. • . E-pay is becoming more and more common in the US. 1-16 © 2016 Pearson Education Ltd. All rights reserved. Evolution of the Payments System • E-Money (electronic money): • Debit card , which look like credit cards, enable consumers to purchase goods and services by electronically transferring funds directly from their bank accounts to a merchant’s account. 1-17 © 2016 Pearson Education Ltd. All rights reserved. Evolution of the Payments System – Stored-value card(smart card) • In Asian countries, such as Japan and Korea , cell phones now have a smart card that raises the expression “pay by phone” to a new level. • Smart cards can be loaded from ATM machines, personal computers with a smart card reader, or specially equipped telephones. – E-cash : A consumer gets e-cash by setting up an account with a bank that has links to the Internet and then transferring the e-cash to her PC. ( pay pal ) 1-18 © 2016 Pearson Education Ltd. All rights reserved. 4- Are We Headed for a Cashless Society? • Predictions of a cashless society have been around for decades, but they have not come to fruition. • Although e-money might be more convenient and efficient than a payments system based on paper, several factors work against the disappearance of the paper system. • However, the use of e-money will likely still increase in the future. 1-19 © 2016 Pearson Education Ltd. All rights reserved. 5-Will Bitcoin Become the Money of the Future? • Bitcoin is type of electronic money created in 2009. • By “mining,” Bitcoin is created by decentralized users when they use their computing power to verify and process transactions. • Although Bitcoin functions as a medium of exchange it is unlikely to become the money of the future because it performs less well as a unit of account and a store of value. 1-20 © 2016 Pearson Education Ltd. All rights reserved. 6- Measuring Money • How do we measure money? Which particular assets can be called “money”? • Construct monetary aggregates using the concept of liquidity: – M1 (most liquid assets) = currency + traveler’s checks + demand deposits + other checkable deposits 1-21 © 2016 Pearson Education Ltd. All rights reserved. Measuring Money • M2 (adds to M1 other assets that are not so liquid) M2 = M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares 1-22 © 2016 Pearson Education Ltd. All rights reserved. The Federal Reserve’s Monetary Aggregates 1-23 © 2016 Pearson Education Ltd. All rights reserved. The Federal Reserve’s Monetary Aggregates M1 (4) M2 (4+3) Currency Traveler’s Checks Demand Deposits Other Check. Dep Small Den. Dep. Savings and MM Money Market Mutual Funds Shares M3 (4+3+4) 1-24 © 2016 Pearson Education Ltd. All rights reserved. The Federal Reserve’s Monetary Aggregates • M1 versus M2: Does it matter which measure of money is considered? • M1 and M2 can move in different directions in the short run (see figure). • Conclusion: the choice of monetary aggregate is important for policymakers. 1-25 © 2016 Pearson Education Ltd. All rights reserved. Figure 1 Growth Rates of the M1 and M2 Aggregates, 1960–2014 Source: Federal Reserve Bank of St. Louis, FRED database: http://research.stlouisfed.org/fred2 1-26 © 2016 Pearson Education Ltd. All rights reserved. Where Are All the U.S. Dollars? • The more than $4,000 of U.S. currency held per person in the United States is a large number. • Where are all these dollars and who is holding them? – Criminals – Foreigners 1-27 © 2016 Pearson Education Ltd. All rights reserved. Thanks for yours attention 1-28 © 2016 Pearson Education Ltd. All rights reserved.
