TOPIC 8 MONEY

An Overview of Money Money is anything that is generally accepted as a medium of exchange. Money is not income, and money is not wealth. Money is: a means of payment, a store of value, and a unit of account.

What is Money? Barter is the direct exchange of goods and services for other goods and services. A barter system requires a double coincidence of wants for trade to take place. Money eliminates this problem. As a medium of exchange, or means of payment, money is generally accepted by buyers and sellers as payment for goods and services.

Functions of money As a means of exchange As a store of value As a unit of account As a standard for deferred payment

Supply of money M1 : consist of coins and notes in circulation and demand deposits M2 : comprises coins and notes in circulation, demand deposits plus savings and fixed deposits M3 : refers to coins and notes in circulation, demand deposits and ‘ all near money’.

The Demand for Money ( keynesian theory ) The main concern in the study of the demand for money is: How much of your financial assets you want to hold in the form of money, which does not earn interest, versus how much you want to hold in interest-bearing securities, such as bonds.

Motives for Holding Money The transaction motive is the main reason that people hold money—to buy things. The precautionary motive – people hold money to guard against unexpected eventuality : illness, accident, car breaking etc. The speculation motive: Because the market value of interest-bearing bonds is inversely related to the interest rate, investors may wish to hold bonds when interest rates are high with the hope of selling them when interest rates fall.

The Total Demand for Money The quantity of money demanded at any moment depends on the opportunity cost of holding money, a cost determined by the interest rate. A higher interest rate raises the opportunity cost of holding money and thus reduces the quantity of money demanded.

The Determinants of Money Demand The interest rate The dollar volume of transactions : a) The aggregate output ( income ) b) The price level

The Equilibrium Interest Rate The point at which the quantity of money demanded equals the quantity of money supplied determines the equilibrium interest rate in the economy.

Changing the Money Supply to Affect the Interest Rate An increase in the supply of money lowers the rate of interest.

Increases in Y and Shifts in the Money Demand Curve An increase in aggregate output (income) shifts the money demand curve, which raises the equilibrium interest rate. An increase in the price level has the same effect.