Chapter 14 Macroeconomics

Barter

trading one good or service for another, without using
money

Double coincidence of wants

a situation in which two people each
want some good or service that the other person can provide

Money

Whatever serves society in four functions:

-Medium of exchange

-Store of value

-Unit of account

-Standard of deferred payment

Medium of Exchange

Whatever is widely accepted as a method of payment

Store of Value

Something that serves as a way of preserving economic value that one can spend or consume in the future

Unit of Account

The common way in which we measure market values in an economy

Standard of Deferred Payment

Money must also be acceptable to make purchases today that will be paid in the future

Commodity Money

An item that is used as money, but which also has value from its use as something other than money

Commodity-Packed Currencies

Dollar bills or other currencies with values backed up by gold or another commodity

Flat Money

No intrinsic value, but is declared by a government to be the country’s legal tender

The Federal Reserve Bank

The central bank of the US

Bank regulator and responsible for monetary policy

Defines money according to its liquidity

The Federal Reserve Bank Has Two Definitions of Money:

M1 Money Supply

M2 Money Supply

M1 Money Supply

A narrow definition of the money supply that includes currency and checking accounts in banks, and to a lesser degree, traveler’s checks

Includes coins and currency in circulation

Checkable (demand) deposits

Traveler’s checks

M2 Money Supply

A definition of the money supply that includes everything in M1, but also adds saving deposits, money market funds, and certificates of deposit

Coins and Currency in Circulation

The coins and bills that circulate in an economy that are not held by the U.S. Treasury, at the Federal Reserve Bank, or in bank vaults

Checkable (Demand) Deposits

Checkable deposit in banks that is available by making a cash withdrawal or writing a check

M2 Money Supply Includes

All M1 Types

Savings deposits

Money market fund

Certificates of deposit (CD’s) and other time deposits

Savings Deposits

Bank account where you cannot withdraw money by writing a check, but can withdraw the money at a bank - or can transfer it easily to a checking account

Money Market Fund

The deposits of many investors are pooled together and invested in a safe way like short-term government bonds

Certificates of Deposit (CD’s) and Other Time Deposits

Account that the depositor has committed to leaving in the bank for a certain period of time, in exchange for a higher rate of interest

Debit Card

Like a check, is an instruction to the user’s bank to transfer money directly and immediately from your bank account to the seller

Credit Card

Immediately transfers money from the credit card company’s checking account to the seller, and at the end of the month the user owes the money to the credit card company

A credit card is not a short-term loan

Not considered money

Smart card

Stores a certain value of money on a card and then one can use the card to make purchases

Payment System

Helps an economy exchange goods and services for money or other financial assets

Transaction Costs

The costs associated with finding a lender or a borrower for this money

Financial Intermediary

An institution that operates between a saver with financial assets to invest and an entity who will borrow those assets and pay a rate of return

Depository Institution

Institution that accepts money deposits and then uses these to make loans

Balance Sheet

An accounting tool that lists assets and liabilities

Asset

Item of value that a firm or individual owns

Liability

Any amount or debt that a form or an individual owes

Net Worth

The excess of the asset value over and above the amount of the liability; total assets minus total liabilities

Bank Capital

A bank’s net worth

T-Account

A balance sheet with a two-count format, with the T-shape formed by the vertical line down the middle and the horizontal line under the column headings for “Assets” and “Liabilities”

The assets of a firm on the left

Its liabilities on the right

Reserves

Funds that a bank keeps on hand and that it does not loan out or invest in bonds

We Define Net Worth of a Bank as its Total Assets Minus its Total Liabilities

For a financially healthy bank. the net worth will be positive

If a bank has a negative net worth and depositors tried to withdraw their money, the bank would not be able to give all depositors their money

Potential Problems for a Bank

High rate of loan defaults

Asset-liability time mismatch

Asset-Liability Time Mismatch

The ability for customers to withdraw bank’s liabilities in the short term while customer’s repay its assets in the long term

Strategies to Reduce Risk

Diversify

Sell some of the loans they make in the secondary loan market

Hold a greater share of assets (government bonds or reserves)

Diversify

Making loans or investments with a variety of firms, to reduce the risk of being adversely affected by the events at one or a few firms

Money Multiplier Formula

1/Reserve Requirement

Banks May Decide to Vary How Much They Hold in Reserves for Two Reasons

Macroeconomic conditions

Government rules