1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics by Fred M Gottheil Chapter 25, Money

2 What is Money? Note that money is a man- made invention: before money, people used barter

3 What is Barter? The exchange of one good for another, without the use of money © ©1999 South-Western College Publishing

4 When can Barter work? When people are basically self sufficient and there is a double coincidence of wants © ©1999 South-Western College Publishing

5 What is a Double Coincidence of wants? A situation in which two traders both have what the other person wants © ©1999 South-Western College Publishing

6 Inefficiency of Barter  Time consuming due to the need for the double coincidence of wants

7 What is Money?  Any commonly accepted good that acts as a:  medium of exchange  a measure of value (unit of account)  a store of value

8 What is commodity money?  Actual products that became acceptable as money, thus had 2 purposes to it: to be used as a product or as money

9 What are the Properties of Money? It must be... durable portable divisible identical scarce stable in supply © ©1999 South-Western College Publishing

10 One commodity that meets most of the requirements of money was of course... GOLD © ©1999 South-Western College Publishing

11 What is Fiat Money? Paper money that is not backed by or convertible into any good © ©1999 South-Western College Publishing

12 What is an example of Fiat Money? Currency - coins & paper money © ©1999 South-Western College Publishing

13 What is Legal Tender? Anything that creditors are required to accept as payment for debts © ©1999 South-Western College Publishing

14 Does gold or silver back up our money? No, our money is not backed up by anything © ©1999 South-Western College Publishing

15 Why does Fiat Money have value? Because it is useful and relatively scarce, and due to its acceptability © ©1999 South-Western College Publishing

16 What does the term Liquidity mean? The degree to which an asset can easily be exchanged for money © ©1999 South-Western College Publishing

17 Which form of money is most Liquid? It depends on the circumstances, in our economy, currency is most liquid © ©1999 South-Western College Publishing

18 For a history of money: arian/llyfr.html © ©1999 South-Western College Publishing

19 What is our Money Supply? Typically, M1 money © ©1999 South-Western College Publishing

20 What is M1 Money? Currency (held outside of banks) Demand Deposits Traveler’s checks Other checkable deposits

21 What is M2 Money? M1 plus less-immediate forms of money, such as savings accounts, money market mutual funds, money market deposit accounts, and small- denomination time deposits © ©1999 South-Western College Publishing

22 What is M3 Money? M2 plus large-denomination time deposits and large- denomination repurchase agreements © ©1999 South-Western College Publishing

23 MI Checkable deposits Travelers checks Currency Money market accounts Savings deposits Small time deposits Miscellaneous moneys Large time deposits M2 M3 + + Measures of Money © ©1999 South-Western College Publishing

24 What is Near Money? Financial assets that can be converted into money such as savings bonds and corporate bonds © ©1999 South-Western College Publishing

25 Are Credit Cards Money? No! Because merchants expect to be paid by the credit card company © ©1999 South-Western College Publishing

26 For an insight of why credit cards are not money visit: © ©1999 South-Western College Publishing

27 Monetary Theory How does monetary policy affect the economy? Differing views on this

28 Begin with the old quantity theory of money, based on the equation of exchange

29 How does the Money Supply effect prices? The Equation of Exchange relates the economy’s price level, the quantity of goods, and the money supply © ©1999 South-Western College Publishing

30 © ©1999 South-Western College Publishing What is the Equation of Exchange? MV = PQ Prices Money QuantityVelocity

31 Note that Q = real GDP, PQ equals nominal GDP

32 What is Velocity? The average number of times per year each dollar is used to transact an exchange © ©1999 South-Western College Publishing

33 Example, suppose PQ, nominal GDP = 8 trillion If the money supply equals 1 trillion, what is velocity? Answer: 8

34 Classical economists believe that the velocity and quantity of output are constant in short-run equilibrium © ©1999 South-Western College Publishing What is the Classical View of Money?

35 Conclusion of the old quantity theory If V and Q treated as constants, then M affects only P-price level is proportional to the money supply

36 36 © ©1999 South-Western College Publishing MV = PQ Prices MoneyQuantity Velocity If V is constant, and if Q is not affected by M, then M can only affect P--this is the conclusion of old classical theory

37 What does the Quantity Theory of Money illustrate? Money does not influence how much we produce but it does influence prices © ©1999 South-Western College Publishing

38 Monetarism, a modern version of the classical quantity theory  Monetarists, V not constant, but stable or predictable  Q tends in the long run to move to its full employment level  Monetarists tend to be critical of allowing the money supply to be too volatile

39 Milton Friedman, best known monetarist Argues that bad monetary policy worsened the great depression Calls for a monetary rule on the part of the Fed, constant growth in the money supply regardless of what is going on in the economy

40 What is the Keynsian View of Money? They reject the idea that V is constant and that Q always reflects full- employment GDP © ©1999 South-Western College Publishing

41 How do the Keynsians view Velocity? Even though they agree that spending and saving are basically stable, velocity is also effected by interest rates and expectations

42 What factors can lead to a rise in velocity? Increased use of electronic banking Use of credit cards Getting paid more frequently Higher rates of inflation Higher interest rates

43 Must look at the demand for money Why hold money instead of other assets?

44 According to the Classical Economist, why do people demand money? People demand money to make transactions © ©1999 South-Western College Publishing

45 What is the Transactions Demand for Money? The quantity of money demanded by households and businesses to transact their buying and selling of goods and services © ©1999 South-Western College Publishing

46 According to the Keynsians, why do people demand money? Transactions motive Precautionary motive Speculative motive © ©1999 South-Western College Publishing

Speculative Motive Individuals may choose to hold bonds over money: Because the market value of interest-bearing bonds is inversely related to the interest rate, investors may wish to hold bonds when the interest rates are high with the hope of selling them when interest rates fall.

48 Due to speculative motive, money demand varies inversely with interest rates

49 i1i1 Money demand curve i2i2 M2M1 D 4949 © ©1999 South-Western College Publishing

50 Now put in a money supply curve, have equilibrium

51 S1 i1i1 Money supply and demand M1M1 D 5151

52 According to the Keynsians, how does money affect GDP? © ©1999 South-Western College Publishing An increase in the money supply increases GDP and not necessarily prices, especially in a recession

53 The Keynesian Transmission Mechanism Increased money supply reduces interest rates, raising planned investment, and thus a multiplier expansion of GDP

54 S1S2 i1 Increase in money from S1 to S2 i2 M2M1 D 5454 © ©1999 South-Western College Publishing

55 i1 An increase in Investments i2 I2I1 I 5555 © ©1999 South-Western College Publishing

56 Aggregate Supply Curve AS AD1 AD2 AD3 AD4 AD5 P GDP 56 AD6 © ©1999 South-Western College Publishing

57 57 © ©1999 South-Western College Publishing oned/curric/money.html

58 What is Barter? What is Money? What are the Properties of Money? What is Fiat Money? Why does Fiat Money have value? What does the term Liquidity mean?What does the term Liquidity mean? What is M1 Money?

59 What is Barter? What is Money? What are the Properties of Money? What is Fiat Money? Why does Fiat Money have value? What does the term Liquidity mean? What is M1 Money? What is the Classical View of Money? What is the Keynsian View of Money?

60 ENDEND © ©1999 South-Western College Publishing