Chapter 12 Money and banking Economics, 8th Edition Boyes/Melvin

Copyright © Cengage Learning. All rights reserved. What is Money? Money is anything that is generally acceptable to sellers in exchange for goods and services. A liquid asset is an asset that can easily (i.e., quickly, cheaply, conveniently) be exchanged for goods and services. Copyright © Cengage Learning. All rights reserved. 5

Copyright © Cengage Learning. All rights reserved. What is Money? Functions of Money Medium of exchange Unit of account Store of value Standard of Deferred Payment Copyright © Cengage Learning. All rights reserved. 6

Copyright © Cengage Learning. All rights reserved. Medium of Exchange (1) The use of money as a medium of exchange lowers transactions costs. Trade without money, directly exchanging goods for goods, is called barter. Barter requires a double coincidence of wants—finding someone who wants what you have and who has what you want is time-consuming and costly. Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. Medium of Exchange (2) A medium of exchange must be: Widely accepted for payment Portable: easy to transport and transfer to the seller Divisible: measurable in both small and large units Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. Unit of Account Money acts as a common unit of measurement, allowing for the comparison of the values of very dissimilar things. Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. Store of Value For money to be a store of value, it must be durable, able to retain value over time. Inflation can reduce the effectiveness of money as a store of value. Copyright © Cengage Learning. All rights reserved.

Standard of Deferred Payment Debt is denominated in money terms. The standard for repayment is money. There is a difference between money and credit: Money is what you use to pay for goods and services. Credit is available savings that are lent to borrowers to spend. Credit is debt, something you owe. Credit cards are not money! Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. M1 Money Supply M1 is the most liquid measure of the money supply. M1 includes: Currency Travelers’ Checks Demand Deposits (checking accounts) Other Checkable Deposits (interest-bearing checking) Demand Deposits and Checkable Deposits are called transactions accounts—checking accounts that can be drawn upon to make payments. Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. About Currency U.S. currency today is not backed by gold or silver. Money backed by gold or silver (or something else of value) is called commodity money. Copyright © Cengage Learning. All rights reserved.

Problems with Commodity Money The precious metal in gold or silver coins may be worth more than the face value of the coins. According to Gresham’s Law, if two coins have the same face value but different intrinsic (commodity) values, the cheaper coin will be used to make transactions and the other coin will be hoarded. “Bad money drives out good.” Copyright © Cengage Learning. All rights reserved.

Copyright © Cengage Learning. All rights reserved. M2 money supply M2 money supply includes the M1 money supply plus: Savings deposits Small denomination time deposits (CDs) Retail money market mutual funds Copyright © Cengage Learning. All rights reserved.

Financial Intermediaries Financial intermediaries are firms that take deposits from households and firms and make loans to other households and firms. Copyright © Cengage Learning. All rights reserved. 21

Financial Intermediaries Four Types of Financial Intermediaries 1) Commercial banks 2) Savings and loan associations 3) Savings banks and credit unions 4) Money market mutual funds Copyright © Cengage Learning. All rights reserved. 22

Copyright © Cengage Learning. All rights reserved. Deposit Insurance To reduce the likelihood of bank panics, the Federal Deposit Insurance Corporation (FDIC) was created. The FDIC insures bank deposits against losses up to $250,000 so that depositors do not lose their deposits if a bank fails. Copyright © Cengage Learning. All rights reserved.