Ch. 10: Money and Banking Section 1: Money • Money is a medium of exchange for resources. Three Uses of Money • Money serves three purposes: – Medium of exchange – Unit of account – Store of value Medium of Exchange • Anything that is used to determine value in exchanging goods. Unit of Account • Provides a way of comparing values of goods and services. Store of Value • Something that holds value if stored rather than used. Six Characteristics of Good Money • • • • • • Durability Portability Divisibility Uniformity Limited Supply Accessibility Durability • Can withstand wear and tear and lasts a long time. Portability • Can be easily moved; small and light. Divisibility • Can be easily divided into smaller units/denominations Uniformity • All of the money units are the same Limited Supply • The money is scarce (limited) to make it valuable. Acceptability • Everyone uses the money/accepts the money. Three times of money • Commodity Money: objects that have value themselves, used for money – Cattle, salt, precious stones Representative Money • Paper certificate that can be exchanged for something of real value (gold, silver) Fiat Money • Currency that is issued by a governing power, and has been ordered acceptable and legitimate. – US Dollar Comparing Money Cattle (Commodity) Representative Cash (Fiat) Durability X X Portability X X Divisibility X Uniformity Limited Supply Acceptablity X X X X X X Section 2: History of Banking • Banking has changed throughout history. Banks • A bank is an institution that receives, keeps, and lends money. Banks vs. Grocery Stores Grocery Stores Banks What they sell Food Money How they make money Charge more for food than they paid for it. Buy food from suppliers Charge more for money than they paid for it. Buy money from people (savings accounts) or other banks (loans) How they get their product Free Banking Era • From 1837-1863, banks could issue their own currency, creating numerous currency options. – Pros? – Cons? Issues with Free Banking • Lack of centralized currency led to… – Wildcat banks/currencies: banks on the “edge” of society (remote areas) that often failed. – Bank runs: panic led to rapid withdrawal – Fraud – Lack of universal acceptability Gold Standard • Required all currency to be equal in value to a certain amount of gold. • Limited amount of currency • Removed in 1930s. Federal Reserve System • Founded in 1913 to serve as nation’s central bank. • The “bankers bank” – Issues money by buying/selling securities – Lends money to banks (determines interest rates) Federal Deposit Insurance Corporation (FDIC) • In the Great Depression, many banks failed and lost their clients money. • Government created the FDIC, which insurers the savings of individuals in approved banks (up to $250,000). Section 3: Banking Today • Banks serve as the foundation of economic activity, their actions greatly impact all other decisions. Money Supply • Money supply- all of the money available in the US economy. • Banks major decision is how much money to make available. Saving Options (Stored Money) • Savings accounts • Checking accounts • Certificates of deposit (CDs) Loans • Banks earn money by loaning out the money they have (your stored money). Fractional Reserve Banking • Banks keep a fraction of what they receive, loaning the rest out. This is cyclical. Mortgage • Mortgage is a specific type of loan used to buy real estate Loans: Principal and Interest • Principal is the amount of money borrowed. • Interest is the price paid to the bank for borrowing the principal. Loans: Principal and Interest • • • • I purchase a house for $200,000 I pay a down-payment of $40,000 My principal is $160,000 and my interest rate is 5% In my first payment, my interest will be 5% of 160,000 divided by 12 months of the year. • What is the interest of my first payment of the loan? • What is the interest of my monthly payment when my principal is down to $100,000? Compounded Interest • Money that is loaned/invested earns compounded interest. • As interest returns, it is added to the principal, then interest is paid for the new principal as well. • This creates exponential returns. Compounded Interest • 72 / interest rate = # of years it takes your money to double in an investment. Compounded Interest • Saving early is important.