Chapter 11
Money
Money



MONEY (def): any commodity or token
that is generally acceptable as a means of
payment
What are the functions of money
 What does money do?
What are the characteristics of money?
 What can be used as money?
What’s it worth?

Yasin’s Shirt?

Sammy’s Shoes?

Grace’s watch?

Taylor’s Phone?
The 3 Functions of money



Medium of Exchange
Measure of value
Store of value
Medium of Exchange



Before, money economies worked on a barter
system (trading)
Barter system works on double coincidence of
wants – seller and buyer must both be willing
In Medium of Exchange


Money acts as a lubricant that smoothes the
mechanism of exchange
Everybody wants currency because they can use it to
get what they want
Medium of Exchange




Saves time over bartering
When you barter it takes time to find someone that has
what you wanted and wanted what you have.
With medium of exchange – you sell to any willing
buyer and buy from any willing seller for currency
Purchasing Power: The amount of goods or services
that can be bought with a unit of currency
Measure of value or Unit of Account

Allows Prices

Standard prices allow commerce to move
faster haggling
http://video.google.ca/videoplay?docid=8650
971429469030558&ei=2yIVS9vVJ4f6lAeilY
y_Dg&q=montey+python+haggle+site%3Ayoutube.com&hl=en#
Measure of value or Unit of Account

Allows Price comparison, which allows decisions

In the barter system the value of a good is worth the value of
many other goods.

1 chicken equals so many loaves of bread, so many litres of milk, pounds
of cheese etc.

In a money system, there is a unit of currency that acts as the
“standard” that can be used to measure against.

Money makes comparison easy


An Ipad = $600 and a PS4 = $600 therefore they are the same price
and are of equal value.
A movie is $10 and an DQ blizzard is $5. A DQ blizzard is half the
price of a movie.
Store of Value

In the barter system one good is sold in place of another good.

Money however, can be held (saved) to delay consumption



Money as well as other assets such a jewellery, real estate, antiques.
However money has the greatest level of liquidity.
Purchasing power in the future should be close to the purchasing
power today
Inflation is the rate by which money looses its purchasing power


How leaky is the batery
Canada has established a policy to control inflation to approximately
2%. This assists in the control of purchasing power.
Store of Value



Store of value is very important in
international trade
People will look for safe harbours
currencies during times of political or
economic turmoil
Traditional Safe Currencies



USD
Euro
CAD
The Big FIVE characteristics of money:





1)
2)
3)
4)
5)
generally acceptable
portable
divisible
hard to duplicate or counterfeit
uniform in value
1) generally acceptable


Older forms of money was generally
acceptable because it had some form of
underlying value i.e. Gold Coins
Fiat (let it be so) money is declared by
government to be considered legal
tender
2) Portable




Money should be easy to carry
Gold other precious metals were heavy
and dangerous to carry
Led to the creation of paper money
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3) Divisible
• Making Change back
in the day
3) Divisible
• In order for currency to be useful it had to be divisible to
reflect a range of values
Canada
• 1 dollar = 100 cents
Britain
• 1 pound = 20 shillings = 240 pence = 960 farthing
India
• 1 gold mohur = 15 silver rupees
• 1 ruppee = 16 annas = 64 paise = 192 pies,
4) Hard to Counterfeit



Rare
It’s a simple tool to help you remember
how to check bills: Touch, Tilt, Look
through, Look at.
http://videos.howstuffworks.com/howstuf
fworks/54-how-money-is-made-video.htm
5) Uniform Value


Durable
Does not loose it’s value

Inflation
Meet Cupad, Cupid's greedy
cousin





Counterfeit
Uniform in value
Portable
Acceptable
Divisible
Classwork P251 1-4
Fake Money

http://bankofcanada.ca/en/video_corp/vi
deos.html
Measuring the money supply


Money: Medium of Exchange
Near Money: Deposits or other assets
that act as a store of value but are not
themselves a medium of exchange
Components of the Money
Supply

Demand Deposits

1.
2.
3.

Money will be transferred “on demand”
Chequing Accounts
Current Accounts (chequing account for business)
Savings Accounts
Term Deposits



Lender agrees to lend money for a fixed amount of
time
At maturity holder will receive money plus interest
Ex Bonds and GIC (Guaranteed Investment
Certificate)
Components of the Money
Supply

Notice Accounts

Require notice to the bank before given
withdraw
Used primarily by business

Some interest paid

Calculating the money
supply





There are many different measures of Canada’s
money supply
Definitions go from narrow (M1) to broad (M2)
The narrowest definition is most easily affected
by monetary policy and assets are most liquid
The broadest definition is the least affected by
monetary policy and assets are least liquid
There is not correct measure of money supply
Definition of the Money
Supply

Bank of Canada (BOC) has a range of definitions of money supply
ranging from very specific to broad (M1-M3)

M1: Narrowest definition of money – medium of exchange


More easily controlled by monetary policy
Most liquid




All currency in circulation outside of banks
Chequing Accounts and Current Accounts
Money in banks and ATMS are not counted because??
M2: Includes all of M1 plus


Savings accounts
Term Deposits
Definition of the Money
Supply

M2++: Includes all of M2 plus – store of
value



Deposits at non-bank deposit-taking
institutions (credit union, caisse populaires)
Annuities at life insurance companies
(Annuities is a mortgage in reverse)
All of these assets can be turned into cash in
two business days
Definition of the Money
Supply

M3: Includes all of M2++ - store of value


Least controlled by monetary policy
Least liquid
 Large
term deposits
 Foreign Reserves
 Funds that are used as a Store of value but can be
converted into cash
Why do we care about
money supply?

Knowing the money supply

Helps BOC determine interest rates and other
financial policies
How much money is in
Canada?
Money Supply In Canada
$Millions
1,400,000
1,200,000
1,000,000
M3
800,000
M2
600,000
M1
400,000
200,000
0
2004
2005
2006
2007
2008
Banking System

Unit Banking: Many independent banks
limited number of branches


US has over 14 000 banks
Branch Banking: Limited number of banks
with unlimited number of branches

Canada has 13
Branch Banking System
Advantages
• Safe – less risk of a
run on the bank
Disadvantage
• Highly concentrated
in few hands
• Little competition
• Higher costs for
consumers
Run on the Bank


Occurs when a large
number of customers
withdraw their
deposits because
they believe that the
bank might become
insolvent (go out of
business)
Driven by fear and
panic
Canada’s Banks

6 banks control over 90% of the banking
assets
Legal Classification

Schedule I banks: Domestic Banks


Schedule II Banks: Canadian Banks that are
subsidiaries of foreign Banks



The 13 Chartered Banks
HSBC Canada
Citibank Canada
Schedule III Banks: Foreign Banks with
branches in Canada

Deutsche Bank
MAGIC or COUNTERFEIT?

How does a Bank turn $100 into $1000?
Reserve Ratio

Reserve requirement is a regulation
that sets the minimum reserves each bank
must hold to customer deposits and notes


Ex. The reserve ratio is 5%
A deposit of $100


$5 Reserve
$95 Can be loaned out
Reserve Ratio Ex

Reserve Ratio: 10%

Tarek deposits $100 in the bank

The bank keeps $10 and lends out $90 to Thea






Thea uses the $90 to pay her employee Sammi who then deposits the
money in the bank
The bank keeps $9 and lends out $81 to Sandra who purchases
supplies from Eric for supplies for her new fashion boutique
Eric deposits the $81 in the bank
The bank keeps $8.10 and lends out $72.9 to Saheel who buys books
for school from Casey’s Book Store
Casey deposits the $72.9 in the bank
The bank keeps $7.29 in reserve and lends out $65.61 to Gordon to
help him pay to record his new country song "your love hurts like a
broken toe"
Reserve Ratio Ex


$100
Could result in a maximum of $1000 in
new money
Reserve Ratios around the
world






India: 5%
China: 15.5%
United States: 10%
Chile: 4.5%
South Africa: 2.5%
Canada: ?
260 Example 1
Change in
Deposits
Change in
Deposits
1
Reserve
Ratio
1
0.1
=
_____________________________
x
Change in
Reserves
=
_____________________________
x
100
Change in =
Deposits
Change in =
Money Supply
1000
900
260 Example 2
Change in
Deposits
Change in
Deposits
1
Reserve
Ratio
1
0.05
=
_____________________________
x
Change in
Reserves
=
_____________________________
x
500
Change in =
Deposits
Change in =
Money Supply
10 000
$9 500
In Class work

Do Questions 1-3 (don’t do #4) on
page 260
260 1
Change in
Deposits
Change in
Deposits
1
Reserve
Ratio
1
0.1
=
_____________________________
x
Change in
Reserves
=
_____________________________
x
5 000
Change in =
Deposits
Change in =
Money Supply
50 000
50 000 – 5 000 = 45 000
260 2
Change in
Deposits
Change in
Deposits
1
Reserve
Ratio
1
0.08
=
_____________________________
x
Change in
Reserves
=
_____________________________
x
10 000
Change in =
Deposits
Change in =
Money Supply
125 000
125 000 – 10 000 = 115 000
P260 3
Change in
Deposits
Change in
Deposits
1
Reserve
Ratio
1
0.20
=
_____________________________
x
Change in
Reserves
=
_____________________________
x
1000
Change in =
Deposits
Change in =
Money Supply
5 000
1000 – 5000 = - 4000
Assets and Liability

A deposit in the bank is both:



Asset (something of value)
Liability (a debt that has to be repaid)
Assets always equal liabilities (+ owner’s
equity)
Creation of money in multibank system (p257)

Scenario:

Bank A has deposit of $10 000





Ms Yeung borrows $9 000
Ms Yeung buys furniture worth $9 000
The store deposits the money Bank B




$1000 Reserve (10%)
$9000 Excess
$900 Reserve (10%)
$8100 Excess
Mr Papas borrows $8100
Mr Papas gives that money to another person who deposits it in
bank C


$810 Reserve (10%)
$7290 Excess
Creation of money in multi-bank
system (p257)

A multibank system will result in the
same amount of new money creation as a
monopoly bank so long as the reserve
ratios is the same
Creation of money in multi-bank
system (p257)



Reserve ratio: 10%
Deposit: $10 000
New money: ?
Creation of money in multi-bank
system (p257)




Reserve ratio: 10%
Deposit: $10 000
New money: A MAXIMUM OF $90 000
Why a maximum?


A bank might not lend out all of its excess
reserves ( High interest, Prudent lending)
Cash Drain People holding (hoarding) money
outside of the banking system
Creation of money in multibank system
Bank A
Bank A - Loan
Assets
Liabilities
Assets
Cash +$10000
Deposit+$10000
Cash
$10000 Initial
$10000
Loan
+$9000 New
+$9000
Total
$19000 Total
$19000
(Required 1000
Liabilities
Excess $9000)
Total
$10000
Total
$10000
Creation of money in multibank system
Bank A - Withdrawal
Assets
Liabilities
Bank B - Deposit
Assets
Liabilities
Cash
$1000 Deposit $10000
Cash
$9000 Initial
Loan
$9000
(Required $900
$9000
Excess $8100)
Total
$10000
Total
$10000
Total
$9000
Total
$9000
Creation of money in multibank system
Bank B - Loan
Assets
Bank C - Deposit
Liabilities
Cash
$9000 Initial
Loan
$8100 New
$9000
+$8100
Assets
Cash
Liabilities
$8100 Deposit $8100
(Required $810
Excess $7290)
Total
$17100 Total
$17100
Total
$8100
Total
$8100
How banks Destroy “money”

The amount of money destroyed is
calculated in the same way as money is
created
How banks Destroy “money”
Bank A
Bank A
Loss of Deposit
Loss of Loan
Assets
Cash
Liabilities
-10000 Deposit -10000
Loan
-9000
Total
-10000
Assets
Loans
Cash
Total
-10000
Total
Liabilities
-9000 Deposit
+9000
0
Total
0
In class work

Pg. 260 #4
P260 4
Bank A
Assets
Cash
-2000
Loan
-8000
Total
-10000
Bank B
Liabilities
Assets
Deposit -10000
Cash
-1600 Deposit -8000
Loan
-6400
Total
-10000
Total
Liabilities
-8000
Total
-8000
How Banks Destroy Money

Someone withdraws money




Bank has a shortfall and must find money to
complete the withdraw
Bank relies on loans being paid back
Banks ceases lending if necessary
This is why banks significantly restricted
lending in the US during the 2008 – 2009
recession
Read P249-254


Answer Questions #1-3 on page 251
Answer Questions on page 261 #1,2,3,4a
Answers to p.251 #1-3

1) medium of exchange is the most
important because money does away with
barter. It is for this reason that money
was developed. The other 2 functions
stem from that same essential function:
money must be accepted as a medium
before it can serve as a measure and a
store of value



2) The store value function is undermined most
severely by inflation, because money loses its buying
power
3 a) Liquidity is the ease with which and asset can be
used to make a payment, money being the most liquid
of assets
B) Canada Savings Bond; shares in a large corporation.
The other three follow in no particular order; they
depend upon whether buyers can easily be found who
will pay for them.
Pg. 261

#1) U.S is much more limited in the number of
branches they are allowed. In the past
Canada’s branch system gave security to the
banks, because one branch could support
another experiencing difficulties. Today both
Canadian and US banks have deposit insurance
in case of bank failures, therefore lessening the
degree of advantage of security that the
Canadian branch system has for depositors.
Pg. 261



#2) The tendancy is that depositors seldom withdraw
the total amount they have deposited, leaving most of
their deposits as excess reserves, which can be used for
lending
#3) it becomes an asset for the bank because the bank
owns it and can use it; it becomes a liability because
the bank owe the amount to the depositer
#4 A $5,000 deposit in a monopoly bank allows a loan
of $45,000; an $18,000 deposit allows a loan of
$162,000
Classwork P251 1-3
1.
2.
Most essential function of money?
Store of value, a lifetime of saving can be
destroyed by inflation
1.
3.
Diversify your portfolio
Liquidity is the ease which an asset can be
converted to cash
1.
2.
3.
4.
5.
Canada Savings Bond
Share in a large corporation
Gold Jewelry
Diamond ring
Rare Painting