AP Econ Unit 8

somethings breaking and I dont think it will last to the end

Barter System

An economic system where goods and services are traded directly without using money

Problem of Barter System

Trade requires a double coincidence of wants meaning both parties must want what the other has

Double Coincidence of Wants

The requirement that each trader must have something the other wants in a barter system

Money

Anything that is generally accepted as payment for goods and services

Wealth

The total collection of assets owned by an individual

Income

The flow of earnings received over a period of time

Legal Tender

Money such as cash and coins that must be accepted as payment

Commodity Money

Money that has intrinsic value and also functions as money such as gold or silver

Fiat Money

Money that has no intrinsic value but is accepted as a medium of exchange such as paper money or digital currency

Medium of Exchange

A function of money that allows people to easily buy and sell goods and services

Unit of Account

A function of money that provides a standard measure of value for goods and services

Store of Value

A function of money that allows people to save purchasing power for future use

Liquidity

The ease with which an asset can be converted into cash or used as a medium of exchange

M1

The most liquid money supply including currency in circulation

M2

A broader money supply that includes M1 plus near money such as time deposits and money market funds

M0

The narrowest money supply including bank reserves and currency in circulation

Time Deposits

Funds deposited for a fixed period such as GICs that are less liquid than M1

GIC (Guaranteed Investment Certificate)

A type of time deposit where money is loaned to a bank in exchange for interest

Money Market Funds

Mutual funds that invest in low-risk short-term debt instruments

Financial Sector

A network of institutions that connect borrowers and lenders including banks and investment funds

Asset

Anything owned that has value either tangible or intangible

Tangible Asset

A physical asset that can be touched

Intangible Asset

A non-physical asset such as financial holdings

Liability

Anything that is owed by an individual or organization

Loan

An agreement where a lender provides money to a borrower in exchange for repayment with interest

Loan as Asset and Liability

A loan is an asset for the lender and a liability for the borrower

Personal Finance

The management of an individual's or family's money including budgeting

Effect of Low Interest Rates on Investment

Lower interest rates encourage more investment

Bond

A debt instrument where the borrower agrees to repay the lender with interest over time

Bond Ownership

Bondholders do not have ownership in the issuing entity

Stock

A financial asset representing ownership in a corporation and a claim on profits

Dividend

A portion of a corporation’s profits paid to shareholders

Bond Interest Rate

The fixed interest rate a bond pays over its lifetime

Face Value of Bond

The amount the bond is worth when issued and repaid at maturity

Bond Value When Market Rates Fall

If market interest rates fall below the bond rate the bond sells above face value

Bond Value When Market Rates Rise

If market interest rates rise above the bond rate the bond sells below face value

Risk of Stocks

Stocks are riskier because their value fluctuates frequently

Risk of Bonds

Bonds are less risky because they tend to maintain stable value

Risk and Return Relationship

Higher returns are associated with higher risk and lower risk with lower returns

Fractional Reserve Banking

A banking system where banks keep only a fraction of deposits as reserves and loan out the rest

How Banks Make Money

Banks earn money by lending out deposits and investing funds while keeping only a portion in reserves

Money Multiplier

A measure of the maximum amount of money that can be created from each dollar of reserves

Money Multiplier Formula

Money multiplier equals 1 divided by the reserve requirement ratio

Reserve Requirement Ratio

The fraction of deposits that banks are required by law to keep as reserves

Effect of Lower Reserve Ratio

A lower reserve ratio increases the money multiplier and allows more money creation

Demand Deposit

Money held in a checking account that can be withdrawn at any time

Required Reserves

The portion of deposits that banks must keep and cannot lend out

Excess Reserves

The portion of deposits that banks can loan out

Bank Lending Process

Banks loan out excess reserves which get redeposited creating multiple rounds of money creation

Balance Sheet Rule

Assets must always equal liabilities plus owners equity on a bank’s balance sheet

Owners Equity

The amount of money the bank owes to its shareholders

Determining Reserve Ratio

The reserve ratio can be calculated using reserves divided by demand deposits

Handling Withdraw Shortages

Banks can borrow from the central bank

Time Value of Money

The concept that money today is worth more than the same amount in the future due to its earning potential

Future Value Formula

Future value equals present value times (1 plus interest rate) raised to the number of periods

Present Value

The current value of a future sum of money discounted by the interest rate

Present Value Formula

Present value equals future value divided by (1 plus interest rate) raised to the number of periods

Quantity Theory of Money

The theory that there is a direct relationship between the money supply and price levels in an economy

Effect of Increasing Money Supply

If the money supply increases prices will also increase assuming other factors stay constant

Quantity Theory Equation

M times V equals P times Y

M in Quantity Theory

Represents the money supply

V in Quantity Theory

Represents velocity of money or how quickly money circulates

P in Quantity Theory

Represents the price level

Y in Quantity Theory

Represents real output or quantity of goods and services

Nominal GDP Identity

P times Y represents nominal GDP

Velocity of Money

The rate at which money is spent in the economy

Effect of Doubling Money Supply

If velocity and output stay constant doubling money supply doubles price level

Monetary Policy

Actions taken by the central bank to influence the money supply and interest rates in the economy

Fiscal vs Monetary Policy

Fiscal policy is controlled by the government while monetary policy is controlled by the central bank

Money Market

The interaction of demand and supply of money that determines interest rates

Transaction Demand for Money

Money people hold to make everyday purchases

Asset Demand for Money

Money people hold because it is less risky compared to other financial assets

Opportunity Cost of Holding Money

The lost interest that could have been earned if money was invested instead of held in cash

Relationship Between Interest Rates and Money Demand

There is a negative relationship where higher interest rates decrease quantity demanded of money

Effect of High Interest Rates on Money Demand

People hold less money and prefer to save or invest it

Effect of Low Interest Rates on Money Demand

People hold more money since there is little incentive to invest

Money Demand Curve

A downward sloping line showing the inverse relationship between interest rates and quantity of money demanded

Axes of Money Market Graph

Quantity of money demanded is on the x-axis and nominal interest rate is on the y-axis

Effect of Price Level Increase on Money Demand

Shifts the money demand curve to the right because more money is needed for transactions

Effect of Income Increase on Money Demand

Shifts the money demand curve to the right because people have more money to spend

Effect of Decrease in Quantity on Money Demand

Shifts the money demand curve to the left

Federal Reserve System (FED)

The central bank of the United States that controls monetary policy

Bank of Canada (BOC)

The central bank of Canada responsible for monetary policy

Money Supply Curve

A vertical line because the central bank sets the money supply independently of interest rates

Expansionary Monetary Policy

When the central bank increases money supply causing interest rates to fall

Contractionary Monetary Policy

When the central bank decreases money supply causing interest rates to rise

Reserve Requirement Tool

Changing reserve ratios where increasing the ratio decreases money supply and decreasing it increases money supply

Discount Rate

The interest rate the central bank charges commercial banks for loans

Effect of Discount Rate Decrease

A lower discount rate increases money supply

Federal Funds Rate

The interest rate banks charge each other for overnight loans

Open Market Operations

The buying and selling of government bonds by the central bank to control money supply

Effect of Selling Bonds

Selling bonds decreases the money supply

Effect of Buying Bonds

Buying bonds increases the money supply

Most Common Monetary Tool

Open market operations are used most frequently by the central bank

Policy Coordination

Fiscal and monetary policies must work together to effectively achieve economic goals

Limited Reserve Economy

A system where banks hold only the required reserves and loan out the rest

Ample Reserve Economy

A system where banks hold reserves greater than the required minimum

Interest on Reserves (IOR)

Interest paid by the central bank to commercial banks on reserves they hold

Purpose of IOR

Encourages banks to keep reserves deposited with the central bank

Discount Rate

The interest rate the central bank charges banks for borrowing money