Lecture macroeconomics chapter 3 1 the monetary system

TOPIC 3 MONEY AND PRICES IN THE LONG-RUN... This section will help you:▪ Define money and discuss its functions.. ▪ Discuss the definition of the money supply.. ▪ Explain how financial

TOPIC 3 MONEY AND PRICES

IN THE LONG-RUN

This section will help you:

▪ Define money and discuss its functions

▪ Discuss the definition of the money supply

▪ Explain how financial institutions create money

▪ Understand tools of Monetary Control

▪ Most people have to spend time searching for others to trade with – a huge waste of resources

▪ Trade without money is known as

direct exchange , or barter

▪ Barter is inefficient because there must be a coincidence

of wants For trade to take place, each must want what the other person has, and must be willing to trade for it

▪ This searching is unnecessary with money,

▪ It facilitates production and trade: people accept money for their own products, and then use

money to purchase other goods and services

Indirect Trade

Money makes trade

much more efficient

Money: the set of assets in an economy that people

regularly use to buy g&s from other people

Medium

of exchange

Unit of account Store of value

The 3 Functions of Money

▪ Medium of exchange: an item buyers give to

sellers when they want to purchase g&s

✓ Liquidity to describe the ease with which an asset

can be converted into the economy’s medium of exchange

▪ Unit of account: is an agreed measure for

stating the prices of g&s and record debts

▪ Store of value: an item people can use to

transfer purchasing power from the present to

one good to be compared with another.

Commodity money:

takes the form of a commodity

with intrinsic value

Examples: gold, silver, shell,

cigarettes…

Fiat money:

money without intrinsic value,

is used as money because of government decree

The Money Supply

▪ The money supply (or money stock):

the quantity of money available in the economy

▪ Assets should be considered as part of MS:

▪ Currency: the paper bills and coins in the

hands of the public

▪ Demand deposits: balances in bank accounts

that depositors can access on demand by writing a check or swiping a debit card

The two most commonly used measures of the money stock,

designated M1 and M2

Defines money according to its liquidity

▪ Currency

▪ Demand deposits

▪ Traveler’s checks

▪ Other checkable deposits ▪ Everything in M1

▪ Savings deposits

▪ Small time deposits

▪ Money market mutual funds

Central Banks & Monetary Policy

▪ Central bank: an institution that oversees the banking system and regulates the money supply

▪ Monetary policy: the setting of the money

supply by policymakers in the central bank

▪ Federal Reserve (Fed): responsible for

regulating the system - an example of central bank in U.S