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
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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
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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.