eco 242.docx

If wage demands are met by squeezing profit margins, then the share of profits in national income will fall. And the share of wages will rise. Unemployment. cost of unemployment social cost crime depression large families in poverty – economic cost social security payment must increase increased family tension-loss of economic output loss of tax revenue Money: development of money ( Shelby commodity gold, sliver ) battering :double coincide of wants ,divisibility – small amounts and exchange rate how much of one good for another . Money: can be defined as anything which is genuinely acceptable as a means of setting a debt obligation. types of money: token money / fiat money and commodity money. token money / fiat money (legal tender)- money which has no intrinsic value, and it is not backed by any physical commodity, and it is acceptable for paying debts e.g. Note and coin commodity money: is a medium of exchange rate that has a commodity and as money ( gold, silver, shells ) functions of money Medium of exchange – refers to the role of money in the exchange of goods and services through the economy. money functions as a standard of deferred payment. money is used in the settlement of future debt obligations. unit of account- money is used as a means of signing value or prices to the vestiary of goods and services throughout the economy. Store of value – is the store of value over time for future enjoyment. Characteristics of money: Money serves as a critical component of an economy, characterized by several essential attributes that ensure its effectiveness. These characteristics include:

1. Durability
   • Money must withstand physical wear and tear over time. Durable materials like metal coins or polymer/plastic notes are often used to ensure longevity.
2. Portability
   • Money should be easy to carry and transfer, enabling transactions to occur conveniently. Its lightweight and compact nature allows it to be transported easily.
3. Divisibility
   • Money must be divided into smaller units to facilitate transactions of varying values. For example, $1 can be divided into 100 cents.
4. Uniformity
   • Each unit of money should be identical to others of the same denomination in terms of value and appearance, ensuring consistency and preventing disputes in transactions.
5. Acceptability
   • Money must be widely accepted as a medium of exchange within a society. This acceptance relies on trust and mutual recognition of its value.
6. Limited Supply
   • To maintain its value, money must be scarce and not easily producible in unlimited quantities. Overproduction or excess supply can lead to inflation and depreciation of its value.
7. Fungibility
   • Each unit of money should be interchangeable with another unit of the same value. For instance, one $10 bill has the same value as another $10 bill.
8. Store of Value
   • Money should retain its value over time, allowing people to save and use it for future transactions without significant depreciation.
9. Medium of Exchange
   • Money is primarily used to facilitate the exchange of goods and services, eliminating the inefficiencies of barter systems.
10. Standard of Deferred Payment
    • Money serves as an agreed-upon measure for settling debts that are paid at a later date.
11. Measure of Value (Unit of Account)

Money provides a consistent standard for pricing goods and services, enabling easier comparisons and valuation. Demand for money – the amount of wealth that everyone in the economy wishes to hold in the form of money balances. The value of money balances is what the public wishes to hold. Theory of demand for money (monetarist): . the quantity theory of money . demand for money. . the theory explaining inflation. this states that the average price of the transaction in an economy is proportional to the nominal quantity of money in circulation. quantity theory of money 1 Fisher equation ( equation of exchange ) equation of exchange – denotes the proportion that the value of goods and services sold must equal the amount of money handled over in exchange M x V = P x T ( TRANSACTION VERSION ) M x V = P x Y ( INCOME VERSION ) m- stock of money in circulation. v- transaction velocity of circulation IE- the average number of times the total the total quantity of money changes hands. P = AVERAGE price of all transactions Y = real output T= QUANTITY OF OUTPUT MV = PT (Y) NOMINAL GDP = NOMINAL GDP- for an increase to occur could be caused by inflation. MV = PY _ _ Y Y

Supply of money

Money supply – the total amount of money in an economy, this consists of currency in circulation plus relevant deposits.

Narrow money supply (m1)-money used as a medium of exchange and consists of notes and coins in circulation, cash held in bank balances, and balances held by banks held by the central bank. Example coins, bills, demand deposit

Broad money supply (m2) -consists of narrow money plus a range of items that are comm rates with money functions as a store of value. Example savings, timed deposits, certificate of deposits.

The central bank (ECCB)-is a financial institution responsible for ensuring the smooth running of the country financial system. its overriding aim operates in the public interest .

Example central bank ( BOJ ) bank of Jamaica

Functions of CB

1. is the government bank i.e it holds the government deposits ( public deposits ), for example, income tax revenue, social security payment
2. it is the banker bank It holds bank deposits which may be used for the following ( to settle debts with each other, to pay money to the governments, to exchange old notes and coins for new ones , to receive money from the government payable to customers e.g wages and salaries.

To hold gold and foreign currencies reserve and management of the exchange equalization account

4 . Issuing of notes and coins

1. Implementation of monetary policies is a government decision to control the money supply and or influence interest rate and the exchange rate .
2. Lender of last resort is the ultimate source of cash for commercial banks and governments.
3. To ensure financial sustainability that is responsible for ensuring the financial system is stable.

CRR=1/R – reserve ratio

Quantitative easing – is a non-traditional monetary policy tool used by central banks to stimulate the economy when the interest rate is near zero and cannot be lowed further the central bank purchases large amounts of financial assets bonds, security etc, To increase money supply lower long term interest rate and interest lending and investment

MONETARIST AND CHANGE IN MONEY SUPPLY IN RETURN ON INVESTEMENT

Monetary policies ( central bank )

Contractionary expansionary

Dampen the economy expand the economy

Reduce money supply increases money supply

Monetary trans mission mechanism – refers to the process by which changes in monetarist polices particularly changes in interest rate or money supply affects the boarder economy including variables like inflation , output and the employment .

Transmission mechanism

Keynesian monetarist

Increase money supply increase money supply

Interest rates falls interest rates falls

Weak increase in investment strong response

Outflow of short term capital outflow of short term capital

Strong increase in investment

Limitation of MP (monetary policies)

It may be inflationary when abused

It’s difficult to eliminate lag in monetary policies time lag

the firm may not use the additional income for productivity

monetarist policies are weakened by fiscal indiscipline Recognition lag

it's difficult to control money supply, especially in the presence of foreign banks

evaluation next Monday

commercial bank and credit union

role of a commercial bank is a profit-making financial institution that lends at higher interest rates than it pays on deposit

roles of commercial bank

lend money to individuals and firms

they accept deposits from citizens and firms

they give financial advice to clients

they provide safe keeping of valuables by using safety boxes

they provide services related to debt payments

example standing orders

they assist the central banks in carrying out government monetary policies

fractional reserve banking: the receipt of new cash by the commercial banking system will lead to a multiple expansion of bank lending and a multiple increase in the money supply

credit creation: is the process by which banks are able to increase the volume of credit by creating loans, the increase results in an increase in the volume of bank deposits and hence the money supply .

cb = crr 20%

initial deposit -$1000

The table is called the money multiplier or the bank multiplier or credit multiplier

• It is multiple by which total bank deposit decrease relative to new cash deposits
• M= 1/crr or 1/r example ½ = 5
• D = 1/r x c
• 5000= 5x 1000

Assuming a required reserve ratio of 10% and initial deposits of $100, illustrate how commercial banks create credit

Ratio 10% deposit of $100

Ad = 1/r x ac

$1000=10x100

Money holding

Currency substitution and money hoarding

Money holding – funds saved but not placed with financial institutions

Currency substitution- (switch to a foreign currency)-when local currencies don’t adequately as a consequence of individual use of foreign currencies

Partial substitution –(US) –

Fully dollarization – individuals switch entirely away from the domestic currency in favor of the US dollar.

This limits the potential of monetary policies

Money and aggregate demand -

Fiscal policies: involve the deliberate invention by the government to manage government expenditure and government income to achieve partial economic and social outcomes.

The instruments of fiscal policies are government expenditure(G) and taxation (T)

Non-discretionary – inbuilt in the economy

Automatic stabilizers- are built-in policies and instruments that reduce or increase the magnitude of fluctuation of output caused by changes in expenditure without government intervention

Examples: PAYE (income tax) / Keynesian concept

Transfer payment

Discretionary

Level

Timing of G & T

Structure (Type of taxation)

Expansionary (reflationary) –

Contractionary (deflationary)- reduce budget deficit

Government budget – projected gov’t spending and projected revenue from taxation

Revenue expenditure

Taxes -direct (specification)

Indirect (ad voloren)

VAT

Direct tax (PAYE)

Progressive –

Proportional - a flat tax

Regressive –

User fees- is a fee you pay for using the service

Expenditure –

Capital expenditure – on infrastructure and physical assets, etc.

Current expenditure (recurrent) -expenditure on recurring items e.g. wages

Transfers – pension, debt interest payment

Budget: revenue > expenditure = budget surplus

Revenue < expenditure = budget deficit

Revenue = expenditure = balanced budget

Deflationary surplus – this occurs when the government cuts expenditure to reduce aggregate demand.

Cyclical surplus – occurs when buoyant economic activities allow the collection of much more tax revenue than is catered for in the budget.

Budget deficit

Reflationary deficit – this occurs when an economy stimulates demand and reduces unemployment through an increase in government expenditure.

A budget deficit occurs when a government's expenditure exceeds its revenue. This situation necessitates borrowing or using reserve funds to cover the shortfall. It is often used as a fiscal policy tool to stimulate economic growth, especially during periods of recession. An important aspect of understanding budget deficits involves distinguishing between different types:

- Reflationary deficit: This type occurs when a government increases its spending to boost demand and reduce unemployment. By injecting more money into the economy, the government aims to stimulate business activities and consumer spending.

- Structural deficit: This is a persistent budget deficit that remains even when the economy is operating at its full potential. It often indicates an imbalance between long-term government revenue and spending.

- Cyclical deficit: This type is related to the economic cycle. During periods of economic downturn, tax revenues may decrease while expenditures on welfare programs increase, leading to a cyclical deficit. Conversely, during economic booms, governments may run surpluses as tax revenues rise and spending on social safety nets decreases.

While budget deficits can be useful in managing economic performance, persistent deficits can lead to increased national debt, higher interest payments, and potential financial instability. Therefore, maintaining a sustainable fiscal balance over the long term is crucial for economic health.

Money and monetary policies exam on Monday

Factional reserve banking – is one in which banks are required to keep a proportion of their deposits as reserves these deposits are held by the central bank and don’t attract interest

Government spending shifts the demand for loanable funds outwards , the government must borrow from the public and the banks to finance its deficit . increase demand from the government increases real interest rates causing private borrowing to fall to L2 and L3 minus L2 is the amount government borrows from the public . banks would respond to higher interest rates by supplying a greater quantity of funds to the government .therefore private borrowing will be crowded out by public borrowing .

Balance budget

( G = T ) Government expenditure = tax revenue

Balance budget multiplier refers to effect on GDP resulting from a simultaneously increase in government spending and equal increase in taxes such that the government budget remains balanced

BBM = 1

The increase in government spending has a larger effect than the reduction in consumption, due to taxes, because government spending directly enters the economy

Example government by 100m would have a greater impact than the taxation

Taxation by 100m .

Copy Table 2 and complete it to show the budget balance indicating whether it is a deficit , surplus or neither 8 marks

With the use of a labelled diagram explain the use of how fiscal policies can solve the problem of unemployment 10marks

Explain using two examples the term automatic stabilizers 8marks