Money, Measurement, and
Time Cost
Roles of Money
 Existence of money improves standard of living, as it
eliminates “double coincidence of needs”
1.
Medium of Exchange – asset used to trade for goods
and services
2.
Store of value – Non-perishable, holds purchasing
power of time
3.
Unit of account – Commonly accepted measure used to
set prices & make calculations
What is Money?
 Any asset that can easily be used to purchase goods and
services
 Three money supply measurements, each more broadly
defined and less liquid than the previous one:
 M1 = Currency in circulation + checkable bank deposits +
traveler’s checks
 M2 = M1 + savings deposits + money market funds +
small time deposits (CDs less than $100,000)


“Near-moneys”
M3 = M2 + large (over $100,000) time deposits
Types of Money
 Commodity money – A good with intrinsic value
 Commodity-backed money – MOE without intrinsic value
but guaranteed by conversion on demand
 Fiat money – MOE with value derived from its official
status as such
 Advantages – Takes up no real resources; amount in
circulation is decided by needs of the economy
 Disadvantages – Can be counterfeited; printing too much
can lead to inflation
Time Value of Money
 In general, having a dollar today is worth more than a
dollar a year from now
 Time value is a consideration when evaluating projects, so
economists use present value to make comparison easier –
using interest rate to compare the value of a dollar received
today with value of a dollar received later
Present Value Equation
To see the relationship between dollars today (present value, or PV)
and dollars one year from now (future value, or FV) a simple equation
is applied:
FV = PV  (1 + r)
Ex. Lending $100 to a friend at 10% interest for one year.
FV = $100  (1.10) = $110
In other words, one year into the future, that $100 will be worth $110.
PV = FV/(1+r)
PV = $110/(1.10) = $100
This tells us that $110 a year from now is worth only $100 in today’s
dollars.
What if we were lending money for a two year period?
FV= PV  (1 + r)² = $100 (1.10)  (1.10) = $121
Conclusions
 Money today is more valuable than the same amount
of money in the future
 The present value of $1 received one year from now
is $1/(1 + r)
 The future value of $1 invested today, for a period of
one year, is $1 (1 + r)
 Interest paid on savings and interest charged on
borrowing is designed to equate the value of
dollars today with the value of future dollars