4.3: Definition, measurement, and functions of money

The barter system

What we would use if we did not have money. Goods and services are traded directly. No exchange of money

Problems with the barter system

• Double coincidence of wants: before trade can occur, each trader has to have something the other wants

• Some goods can not be split: chickens, giant rocks, etc.

Money

Anything that is generally accepted as payment for goods and services. NOT the same as wealth and income

wealth

total collection of assets

income

flow of earnings per unit of time

Commodity Money

Something that performs the value of money and has intristic value

gold, silver, cigarettes

Fiat money

Something that serves as money but has no other uses or value

Paper money, coins, digital currency

Three functions of money

• medium of exchange

• unit of account (meausre of value)

• store of value

Medium of exchange

Money can be used to buy goods and services with no complications of the barter system

A unit of account (measure of value)

Money measures the value of all goods and services. Money acts as a measurement of value.

A store of value

money allows you to store purchasing power for the future

What backs the money standard

Not gold. Comes from our collective belief that it is valuable

What makes money effective

Generally accepted: buyers and seller have confidence that it is legal tender

Scarce: money must not be easily reproduced

Portable and dividable: money must be easily transported and divided

Purchasing power of money

the amount of goods and services a unit of money can buy

Inflation

decreases the purchasing power of money

hyperinflation

decreases acceptabillity

Liquidity

ease with which an asset can be accessed and used as a medium of exchange

M1 (highest liquidity)

• Currency in circulation (money in your wallet)

• Checkable bank deposits (checking accounts)

• Saving deposists (money market accounts)

M2 (near moneys)

ALL OF M1+

• Time deposits (CDs= certificate of deposits)

• Money market funds

Both M1 and M2

Earn little to no interest so the opportunity cost of holding liquid money is the interest you could be earning

you want to have the highest liquidity for

paying taxes