1 15.Nature and Functions of Money

Chapter 15 : main menu 15.1 The problems of barter and how they are solved by money Concept Explorer 15.1 Theory in Life The functions of money 15.3Properties of moneyProgress Checkpoint Different forms of money Theory in Life 15.2 Theory in Life 15.3 Progress Checkpoint The Hong Kong Three-tier System Concept Explorer 15.2 Concept Explorer 15.3 Concept Explorer 15.4 Theory in Life 15.4 Concept Explorer 15.5 Progress Checkpoint Definitions of money supply

3 Concept Explorer 15.1 Credit cards and the functions of money What functions of money do credit cards perform? Are credit cards money?

4 Concept Explorer Medium of exchangeA credit card is a temporary medium of exchange, because we can present it and exchange for goods. 2. Unit of accountA credit card is not a unit of account, because the prices of goods is not measured in terms of number of credit cards. 3. Store of valueA credit card is not a store of value, because our wealth and purchasing power cannot be stored in credit cards. 4. Standard of deferred paymentA credit card is not a standard of deferred payment, because future debts and payment are not expressed in terms of number of credit cards.

5 As credit cards cannot settle transactions and debts, they are not money. Yet, credit cards can act as a means of deferred payment, because cardholders can defer payment by asking banks to pay for them temporarily. Reminder : Money is only a standard of deferred payment, but NOT a means of deferred payment. Concept Explorer 15.1

6 Theory in Life 15.1 Identifying whether there is money Is there money in each of the following case? 1. In economy A, people sell commodities in return for coal, and they use coal to buy goods. Is there money? Coal is used as a generally accepted medium of exchange. Hence money exists. 2. In prison, some prisoners use cigarettes to settle payment for gambling. Is cigarette money inside prison? Although cigarettes is used to settle gambling payment, the prisoners cannot use cigarettes to exchange for other commodities. Thus cigarette is not money inside prison. 3. Octopus cards are widely used in Hong Kong nowadays. Is an octopus card money? Holders of octopus card need to transfer cash or deposits into the card before use. Thus the cash or deposits are money, but the Octopus card itself is not money. 4. In 2050, it is predicted that all payment in Hong Kong can be conducted with deposits transferred within banking system. No cash will be required. Will there still be money? As deposits in banks are widely as a generally accepted medium of exchange to settle payment, money exists.

7 Progress Checkpoint 1 Q15.1 Peter : I want to trade my potato with your tomato now. Tom : But I wanted to exchange my tomato with potato two weeks ago. What I want now is some fish. Explain what problem of exchange exists in this case and how money solves the problem.

8 The problem is a lack of double coincidence of wants. This is because Tom does not want to exchange the potato Peter has at the same time. With money, Tom can sell tomato to Peter first, and use the money to buy fish from someone later. The acts of purchase and sale are separated. Progress Checkpoint 1

9 Q15.2 Which function of money will be affected most in times of inflation? Store of value, because the purchasing power of money will fall in inflation. Progress Checkpoint 1

10 Q15.3 Why is gold a better form of money than pearl? Give THREE reasons. It is because gold is more generally acceptable, scarce, easily divisible and homogeneous. Progress Checkpoint 1

11 The Easy Pay System and the Payment-by-Phone System Can savings deposits perform the medium of exchange function? The Easy Pay System (EPS) ( ) and the Payment-by- Phone System (PPS) ( ) enable savings deposits to be used as a medium of exchange. Through the integrated terminals, phone system or internet, customers may pay by directly transferring their demand or savings deposits to the sellers bank account immediately. Theory in Life 15.2

12 The choice of investment opportunity After retirement, Rick receives $1 million from pension scheme. He is considering whether to deposit this amount in savings account, time deposits account or to buy shares. What will be the suitable choice if he wants to (a) have high liquidity, (b) have certain return, (c) have the maximum possible return, and (d) avoid risk? Theory in Life 15.3

13 Liquidity ( ) refers to the ease of converting an asset ( ) into cash at low cost. If he wants to have high liquidity, he should deposit his money in a savings account. This is because he may withdraw the money at any time. If he wants to have certain return, he should deposit his money in a time deposits account. This is because the interest rate is fixed. He knows how much interest to obtain. Theory in Life 15.3

14 If he wants to have the maximum possible return, he should buy shares. This is because if share prices rise sharply, his return will be very high. If he wants to avoid risk, he should deposit his money in a time deposits account. This is because the interest rate is fixed. For savings deposits, the interest rate can be adjusted by banks from time to time. Theory in Life 15.3

15 Progress Checkpoint 2 Q15.4 Banknotes and coins in Hong Kong have no intrinsic value. Why do we use them as money? It is because the government declares them as legal tender, and we generally accept them as medium of exchange.

16 Q15.5. Do Octopus cards perform the functions of money as a unit of account and a standard of deferred payment? No. Prices of commodities and future payment are not expressed in terms of number of Octopus cards. Progress Checkpoint 2

17 Q15.6 Is there money in a Robinson Crusoe (i.e. one-man) economy? No, because there is no market exchange Progress Checkpoint 2

18 Concept Explorer 15.2 Cash Vs Money Is there anything money but not cash? Is there anything cash but not money? Is there anything both money and cash?

19 When cash is possessed by the public, it is money. This is because the cash held will be used as a medium of exchange in market transaction. However, when the public deposit cash, the cash will be kept by banks as reserves ( ). Banks do not use these reserves for their own expenses. They will either pay the reserves to the public who withdraw deposits, or lend them to other borrowers. Since both are not market transactions of final output, the reserves are not used as a medium of exchange. Therefore, cash reserves kept inside banks are not money. Concept Explorer 15.2

20 Concept Explorer 15.2 CashMoney (M1) Cash held by banks = reserves Cash held by public Dd in banks

21 M1, M2 & M3 Given the following information: Concept Explorer 15.3 HK$ (million) Cash held by non-bank public200 Cash held within monetary sector400 Savings deposits500 Time deposits in licensed banks1,000 If M2 = $2 000 million, what are the values of (a)demand deposits, (b)(b) M1 and (c) total amount of bank deposits?

22 M2 = Cp + Dd + Ds + Dt b M1 = Cp + Dd $2 000 m = $(200 + Dd ) m M1 = $( ) m Dd = $300 m M1 = $500 m Total amount of bank deposits = Dd + Ds + Dt banks = $( ) = $1 800 m Concept Explorer 15.3

23 Concept Explorer 15.4 M1, M2 & M3 Given the following table. What are the values of (a) currency in public circulation, (b) M1, (c) M2 and (d) M3 respectively? HK$ (million) Total issue of legal tender100,000 Legal tender held by authorized institutions20,000 Demand deposits with licensed banks150,000 Savings deposits with licensed banks130,000 Time deposits with licensed banks400,000 Negotiable certificates of deposits issued by licensed banks and held by the public350,000 Deposits with restricted licence banks and deposit-taking companies200,000 Negotiable certificates of deposits issued by restricted licence banks and deposit- taking companies held by the public 150,000 Negotiable certificates of deposits issued by restricted licence banks and deposit- taking companies held by authorized institutions 50,000

24 (a) Currency in public circulation (Cp) = Total issue of legal tender – Legal tender held by authorized institutions =$( – ) m =$ m Concept Explorer 15.4

25 (b) M1= Cp + Dd = $( )m = $ m (c) M2= M1 + Ds + Dt banks + Cd banks = $( )m = $ m (d) M3= M2 + D RLB + D DTC + CD RLB + CD DTC = $( )m = $ m Concept Explorer 15.4

26 Theory in Life 15.4 The Payment-by-Phone System Kyle settles his mobile phone bill by the Payment-by- Phone System (PPS). When he uses the service, the amount of payment is deducted from his savings account, and the savings account of the mobile phone service company in bank will be credited by the same amount. How is money supply M2 affected?

27 When deposit is deducted from Kyles bank account, M2 decreases. When it is transferred to the companys bank account, M2 increases by the same amount. Therefore M2 is not affected. Theory in Life 15.4

28 Concept Explorer 15.5 The change in M1, M2 & M3 How will M1, M2 and M3 be affected in each of the following cases? (a)Mr. A transfers $100 from current account in savings account. (b)Mr. B returns the certificate of deposits to a deposit- taking company, and deposits the $1 million received into a current account.

29 (a)When Mr. A withdraws $100 from current account, demand deposits falls by $100. Thus M1, M2 and M3 fall by $100. When he deposits the $100 in savings account, savings deposits rises by $100. Thus M2 and M3 rise by $100. Finally, M2 and M3 do not change. (b)When Mr. B withdraws $1 million from a DTC, CD issued by a DTC but held by the public falls by $1 million. Thus M3 falls by $1 million. When he deposits this amount in a current account, demand deposits rises by $1 million. Both M1 and M2 rise by $ 1 million. As M3 includes demand deposits, M3 rises by $1 million. Finally, M3 does not change. Concept Explorer 15.5

30 Progress Checkpoint 3 Q15.7 Suppose Sonia withdraws deposits from a time deposits account in a licensed bank, and buys a certificate of deposits issued by a deposit-taking company, how will M1, M2 and M3 be affected? When she withdraws deposits from the licensed bank, M2 will fall. When she buys a CD issued by a DTC, M3 does not change. This is because M3 includes both time deposits in licensed bank and CD issued by DTC. M1 also does not change.

31 Q15.8 Arrange the following items in terms of liquidity (i.e. the ease of converting it into cash) in ascending order : (a)certificate of deposits issued by a licensed bank (c)real properties (b)currency (d)savings deposits Real properties, CD s,, savings deposits, currency. Progress Checkpoint 3

32 End of Chapter 15