Unit IV (Money)

• Uses of Money: 

-Medium of exchange: trade or barter

-Unit of account: establishes economic worth in the exchange process 

-Store of value: money has its value over a period of time, where products may not  

• Types of Money: 

-Commodity money: gets it value from the type of material from which it is made

    ex: gold and silver coins 

-Representative money: paper money backed up by something tangible that it gives it value  

Fiat Money: money because government says it is money and that is used in the U,S 

• Characteristics of money: 

-portable 

-durable

-uniform

-scarce

-acceptable 

-divisible  

• Money Supply:

-M1 money: currency (cash, coins, checkable deposits/ checking account, traveler's checks, and demand deposits) 

-75% of money in circulation and it mostly liquid because it easy ti convert to cash  

-M2 money: consists of M1 money  + savings accounts and deposits held by banks held outside of the U.S

-M3 money: consists of M2 money + certificates of deposits, known as CD's 

 

• time value of money:

Is a dollar today worth more than a dollar tomorrow?

-YES 

-Why?

-opportunity cost and inflation

-let v= future value of money

-let p= present value of  money

-let r= real interest rate (nominal rate- inflation rate) expressed as a decimal  

-let n = years

-let k= # of times interest is credited per year

-simple interest forumla: v=  (1+r)^n * p 

-compound interest forumla: v= (1+r/k)^nk *p 

• demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded  
• what happened to the quantity demanded of money when interest rates increase?

-quantity demanded falls because individuals would prefer to have interest rate assets instead of borrowed liabilities

• what happens to the quantity demanded when interest rates decrease? 

-quantity demanded increase, there is no incentive to convert cash into interest earning assets      

• Demand for money 

-money demand shifters:

1. change in price level
2. change in income 
3. change in taxation of investments

-How money supply affects AD? 

-money supply increases= decrease in interest rates, increase in investments, and decrease in AD

-money supply decreases = increase in interest rate, decrease in investment, decrease in AD

-Financial Assets vs Financial Liabilities 

-FA: assets such as stocks and bonds provide expected future benefits 

            - it benefits the owner, based upon the issue of the asset meeting certain obligations

-FL: liabilities incurred by financial asset to stand behind the issued asset  

-Interest rate: price paid for a financial asset 

-Stocks vs Bonds: 

-Stocks: assets that convey ownership in a company

-Bonds: promise to pay a certain amount of money + interest in the future

-What banks do?

- it is a financial intermediary  

-uses liquid assets (i.e. bank deposits) to finance the investments of borrowers

-process known as Fractional Reserve Banking

  - a system in which depository institutions hold liquid assets > the amount of deposits  

     -can take form of:  

• currency in bank vaults 

• bank reserves: deposits helad at federal reserves