Means Of Exchange Store Of Purchasing Power Measure Of Value Functions of Money
Means of Exchange Without money, market participants must trade one product for another product, a transaction known as barter. For example in a barter market, a barber who would wants to buy a clock must find a clockmaker who wants a haircut. Because it is hard for a barber to find a clockmaker that wants a haircut, trade is hence discouraged, so most people living in a barter system produce many items for themselves.
Means of Exchange Continued The benefits of money as a means of exchange are far-reaching. People can minimize the time they spend finding others with whom they can buy and sell. Specialization promotes the division of labor and allows an economy to achieve higher levels of output. Therefore, the use of money not only facilitates transactions of goods and services - it also raises living standards.
Store of Purchasing Power Moneys second function is to providing a safe and accessible store of wealth. Money is an attractive store of purchasing power during the period from when it is earned to when it is spent. The advantage of money is its liquidity. Assets are most liquid when they can be quickly turned into money with little or no loss. For an economic choice there is and opportunity cost. People hold wealth as money when –BENEFITS OF LIQUIDITY > THE INCOME IT COULD EARN IN A DIFFERENT FORM.
Measure of Value Money provides buyers and sellers with a unit of account, or pricing standards. The unit of account allows all products to be valued consistently against a common measure – in other words, it provides a point of comparison between two products. So if apples and oranges cost $ 2.00/kg and $ 4.00/kg respectively, one can say that oranges cost double that of the cost of the apples. The unit of account does the same on a grander scale; expressing GDP as a dollar value simplifies the picture by allowing a wide range of products to be quantified and combined.
The Canadian Financial System The supply of money is closely associated with institutions known as deposit takers (bank itself) which accepts funds provided by savers and lend these funds to borrowers. Therefore the money the bank borrows from the savers is a liability, but on the other hand the money it lends out to money borrowers are its assets. Therefore, the profit maker, for the deposit takers is the difference in the interest charged by the lenders and the interest charged by the banks to its money borrowers.
The Canadian Financial System Continued Cash reserves are the amount of money that flows into the institution but doesnt flow out. It is used, when money borrowers come to the institution to make actual cash withdrawal. The deposit takers make no profit on these cash reserves. Deposit takers can be categorized as chartered and near banks.
Chartered Banks Chartered banks are regular banks that form the backbone of the Canadian Financial System. These banks receive charters from the federal government, allowing the banks to sell a variety of financial services. Therefore, this oligopoly market is dominated by:
Near Banks Near banks, unlike chartered banks have more specialized services. The most important are trust companies, mortgage loan companies and credit unions.
The Supply of Money The supply of money is made up of : –Currency –Deposits –Demand Deposits –Notice Deposits –Term Deposits –Foreign Currency Deposits
Credit and Debit Cards Credit Cards: a means of payment that provides instantly borrowed funds. There are a variety of credit card companies such as Master Card, Visa and American Express which one uses to build upon their credit. Ones credit can be used to borrow funds from money lenders, to for example to buy a house etc. Debit Cards: a means of payment that instantaneously transfers funds from buyer to seller. The money is instantaneously debited from ones account and directly deposited into anothers account.
The Demand for Money To Recall: Money functions as a means of exchange, a store of purchasing power, as well as a measure of value. Money as a means of exchange and a store of purchasing power are reasons why money is demanded within the economy.
Transactions Demand This function is connected to moneys use as means of exchange. If real output in the economy increases, then transactions also increases and vice versa. If price levels in the economy increases, then quantity of money exchanged also increases and vice versa The relationship between real output and transactions, as well as price levels and quantity of money exchanged is direct. Moreover, any changes in the transactions will affect the amount of money demanded.
Asset Demand Connected to moneys function in terms of a store of purchasing power. Recall: main cost of holding money is the added income that could have been earned by converting into a higher-paying liquid asset like a bond. Bonds are defined as formal contracts that set out the amount borrowed, by whom, for what period of time, and at what interest rate. The most popular way for large businesses and governments to raise funds is with bonds because they can be bought easily and sold before their term ends. They also offer liquidity and relatively high rates of returns. Beneficial to those who hold wealth because bonds offer the likeliest alternative for holding money.
Asset Demand Continued Asset demand for money is inversely related to the real interest rate on bonds. Example: If the interest rate increases, bond prices decreases, which causes more people to convert their own money into bonds and thereby decreasing the asset demand for money. By contrast, if the interest rate decreases, bond prices increases, causing wealth holders to hold on their money and thereby increasing the asset demand for money. Money Demand: The amounts of money demanded at all possible interest rates. It can be shown in a table called the money demand schedule and on a graph where money demand is called the money demand curve.
Asset Demand Continued Slope of money demand curve negative at lower interest rates, there is a greater quantity of money demanded. Slope is determined by asset demand for money. Since the relationship between asset demand for money and real interest rates on bonds is inverse a change in asset demand causes a change in the quantity of money demanded, or a movement along the demand curve.
Asset Demand Continued Example: If interest rates rise from 3% to 5%, the quantity of money demanded will decrease (from point b to point a). A change in the transactions demand will change the amounts demanded at all interest rates (It causes an entire shift in the money demand curve). Transactions demand is affected by either an increase or decrease in either real output or the price levels in the economy. In figure 14.3, an increase in transactions demand shifted the money curve to the right from D m0 to D m1.
The Supply For Money A set amount determined by government decision-makers. Like money demand, money supply can be expressed in a money supply schedule and on a graph which shows the money supply curve. Amount of money supplied is always perfectly elastic and stays at a constant value shown which is shown through the vertical supply curve. Only shifts if government decision-makers decide to change the money supply. An increase shifts it to the left, and a decrease shifts it to the right.
Equilibrium in the Money Market Laws of supply and demand for money bring about equilibrium in money market. Intersection of money demand and supply indicate equilibrium for real interest rates and quantity demanded at that rate. A surplus occurs when at any point on the graph where Sm > Dm at a particular interest rate.
Equilibrium in the Money Market Continued A shortage occurs when at any point on the graph where Dm > Sm at a particular interest rate. If a surplus occurs, people will want to buy assets that will provide high future earnings causing demand for assets to rise, which forces bond prices to increase as well and causing real interest rate to decrease. If a shortage occurs, people will want to sell their assets to get money, forcing asset prices to fall, which causes real interest rate to increase. These trends of interest rates falling and rising will continue until equilibrium is reached.
The Bank of Canada Has served as Canadas central bank since 1935 It is a wholly government-owned institution The Bank has been give four basic functions relating to money and the financial system: –Managing the money supply –Acting as the Bankers bank –Acting as the federal governments fiscal agent –Ensuring the stable operation of financial markets
Managing the Money Supply Most important role of the Bank of Canada is to control the amount of money circulating in the economy The Bank decides and implements monetary policy The Bank issues paper currency and affect the activities of chartered banks to adjust the interest rate and the supply of money
Managing the Money Supply Continued The Bank of Canada has three main goals with managing the money supply –Minimizing inflation in order to preserve the purchasing power of the dollar –Maintaining real output as close as possible to its potential level –Regulating the external value of the Canadian dollar on foreign exchange markets
Acting as the Bankers Bank The bank holds the deposits of financial institutions that are members of the Canadian Payments Association (CPA) CPA includes the chartered banks and some near banks. The association also acts as a cleaning house for cheques of both chartered banks and near banks.
Acting as the Bankers Bank Continued For example, the Depositor A has a chequing account with Canada Trust. He writes a $50 cheque to Depositor B, who deposits this cheque in her account at Scotia Bank, increasing her deposit balance by $50. Scotia Bank delivers the cheque to Canada Trust, and receives $50 in return. This payment between the two banks is actually made by using the accounts kept by both institutions at the Bank of Canada. The $50 is transferred from Canada Trusts account to Scotia Banks account at the Bank of Canada. To complete the entire exchange, Canada Trust then cancels the cheque it has received and reduces Depositor As deposit account by $50. Each day, every cheque transaction like this is added up by the Bank of Canada, and the accounts of members of the CPA are all cleared at once.
Acting as the Bankers Bank Continued Cash reserves from the chartered banks are accounts held at the Bank of Canada When a chartered bank finds that its cash reserves are too low, it can borrow from the Bank of Canada. The Bank provides a short-term loan by depositing the required funds in the chartered banks account at the Bank of Canada. Bank rate : the interest rate chartered banks are charged on advance from the Bank of Canada Because the bank rate is higher then the interest rates on other available sources of loans, chartered banks rarely take out Bank of Canada advances.
Acting as the Federal Governments Fiscal Agent The Federal government needs a bank to manage its transactions and financial assets The Bank of Canadas responsibility as the governments fiscal agent are –Holding some of the governments bank deposits and decides where other deposits should be held –Acts as the government banker by clearing federal government cheques –Handles the financing of the federal governments debts by issuing bonds
Acting as the Federal Governments Fiscal Agent Canada Savings Bonds : federal government bonds that have a set value throughout their term –S–Savers know exactly how much they will receive for the bond during its entire term –I–Increases the attractiveness to Canadian Savings Bonds Treasury bills : short-term federal government bonds that provide no interest, but are sold at a discount –T–Terms of three months to a year –U–Usually issued in large denominations –S–Sold at a marked down price
Acting as the Federal Governments Fiscal Agent For example, a treasury bill is worth $100 000 might be bought for $95 000. Once the treasury bill matures, the holder receives the face vale of $100 000, thereby earning an income of $5000. The price for federal treasury bills is decided at an auction conducted each Tuesday by the Bank of Canada
Ensuring the Stability of Financial Markets The Bank of Canada supervises the operation of financial markets to ensure the stability of them, especially for chartered banks. This protects the safety of depositors funds and the soundness of the financial system