Money, Measurement, and Time Cost
What is Money? Any asset that can easily be used to purchase goods and services Two monetary aggregates define this differently: M1 = Currency in circulation + checkable bank deposits + traveler’s checks M2 = M1 + savings deposits + time deposits + money market funds
Roles of Money Existence of money improves standard of living, as it eliminates “double coincidence of needs” 1. Medium of Exchange – asset used to trade for goods and services 2. Store of value – Non-perishable, holds purchasing power of time 3. Unit of account – Commonly accepted measure used to set prices & make calculations
Types of Money Commodity money – A good with intrinsic value Commodity-backed money – MOE without intrinsic value but guaranteed by conversion on demand Fiat money – MOE with value derived from its official status as such Advantages – Takes up no real resources; amount in circulation is decided by needs of the economy Disadvantages – Can be counterfeited; printing too much can lead to inflation
Time Value of Money In general, having a dollar today is worth more than a dollar a year from now Time value is a consideration when evaluating projects, so economists use present value to make comparison easier – using interest rate to compare the value of a dollar received today with value of a dollar received later
Present Value Equation Amount received one year from now as a result of lending: $X + ($X r) OR $X (1 + r) Amount lent today to receive $1 a year from now: $X = $1/(1 + r) For lending beyond one year: $X (1 + r) N AND $X = 1/(1 + r) N with N = # of years lent
Evaluating Using Present Value Project Dollars realized today Dollars realized in one year Present value calculation Net present value given r = 0.10 A$100$0 B-$10$115 C$119-$20
Monetary Equation of Exchange Depicts the relationship between money supply, income velocity, price level, and real output MV = PQ Changes in money supply result in changes in nominal GDP (P Q) Like the Savings-Investment Spending Identity, this is always true