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Principles of economics openstax chapter27

# Chapter
27 Money
and Title
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Money is anything that is generally accepted as a medium of payment.

Money is not income, and money is not wealth. Income and wealth are measured in

Money has the following functions:

• Medium of payment
• Store of value
• Unit of account

Money: Medium of Payment

Barter system: direct exchange of goods and services for other goods and

Barter system requires a double coincidence of wants for trade to take place.

Money eliminates the barter problem and facilitates market transactions.

Money: Store of Value
The value of money is the purchasing power embodied in it. Why do we prefer a
$100 bill to a $1 bill?
Money is as an asset that can be used to transport purchasing power from one time
period to another.
Money is easily portable across time and space.

Money: Unit of Account

Money serves as a unit of account for

• quoting prices
• keeping books
• calculating debts

Types of Money

Commodity Money: an item used as money that also has intrinsic value in some
other use (e.g., gold & silver).

Fiat or Token Money: money that is intrinsically worthless (e.g., coins & bills).

Legal Tender: money that a government requires to be accepted in settlement of
debts (e.g., dollar bills).

Token Money

For centuries, the extremely durable cowrie shell was used as a medium of exchange in
various parts of the world.

Fiat money

Until 1958, silver certificates were commodity-backed money—backed by silver, as indicated by the
words “Silver Certificate” printed on the bill. Today, U.S. bills are backed by the faith of people on the
US economic system.

Supply of Money
M1 or Transactions Money is money that can be directly used in transactions.

M1 = currency held outside banks + checking accounts + plus traveler’s checks + other
checkable deposits

Checking accounts are called “demand” deposits

Supply of Money

M2 or Broad Money includes near monies that are close substitutes for
transactions money.
M2 = M1 + savings accounts + money market accounts + other near monies
Saving accounts are called “time” deposits

M1 and m2

M1 = coins and currency in circulation + checkable (demand) deposit + traveler’s checks.
M2 = M1 + savings deposits + money market funds + certificates of deposit + other time

Commercial Banking: Bank Reserves
Total Reserves = Total deposits at a bank
Required Reserves: A fraction of Total Reserves a bank must hold at its account
in the FED
Excess Reserves: The rest of Total Reserves that a bank can use for loans

Commercial Banking: Money Creation

Banks use their Excess Reserves to make loans.

E x c e s s R e s e rv e s ≡ T o ta l R e s e rv e s − R e q u ire d R e s e rv e s

Commercial Banking: Money Creation

Banks act as financial intermediaries because they stand between savers and borrowers.
Savers place deposits with banks, and then receive interest payments and withdraw
Borrowers receive loans from banks and repay the loans with interest. In turn, banks return
money to savers in the form of withdrawals, which also include interest payments from
banks to savers.

Commercial Banking: Money Creation

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