What is Money?

Introduction to Measures and Definitions of Money

  • Speaker: Jacob Reed from ReviewEon.com

  • Objective: Understand the measures and definitions of money.

  • Resource: ReviewEon.com for additional materials such as the total review booklet for microeconomics or macroeconomics exams.

The Barter System

  • Definition: Barter is the exchange of goods and services for other goods and services, without money.

  • Example: If one person has an umbrella and wants a hammer, they must find someone who has a hammer and wants an umbrella.

  • Key Concept: Mutual Coincidence of Wants

    • To make a trade, both parties must want what the other has.

  • Drawback: The barter system increases transaction costs due to the need for both parties to match their wants.

Functions of Money

  • 1. Medium of Exchange

    • Money enables a more efficient trading system than barter, reducing transaction costs significantly.

    • Example: A person with an umbrella only needs to find someone willing to pay with money, rather than another person who wants an umbrella.

  • 2. Unit of Account

    • Money serves as a standard of value for priced goods and services.

    • Prices are expressed in dollars, allowing for easy comparison.

    • Example: Different prices for various fruits guide purchasing decisions based on perceived value.

    • Real-life Scenario: A $22,000 car vs. a $60,000 car creates distinct mental images based on price.

  • 3. Store of Value

    • Money preserves the value of labor and resources over time.

    • Example: A farmer's strawberries will spoil, but selling them for money converts their fleeting value into something lasting.

    • Limitations: Inflation impacts the effectiveness of money as a store of value; purchasing power can diminish.

    • The Federal Reserve targets a 2% annual inflation rate, meaning that the value of money decreases annually by this percentage.

Origin and Evolution of Money

  • Original Forms of Money:

    • Typically included commodity money like livestock, bushels of wheat, cowry shells, and gold.

    • Commodity Money: Has intrinsic value (for example, gold has physical worth).

  • Transition to Representative Money:

    • Each currency bill was backed by a commodity (e.g., $500 gold certificate).

    • This system is largely outdated today.

  • Modern Money:

    • Fiat Money: Current currency has value because the government backs it; it lacks intrinsic value and commodity backing.

    • Example: The U.S. dollar is not backed by gold or silver and is considered legal tender for all debts, public and private.

Measuring the Money Supply

  • 1. Monetary Base (M0):

    • Narrowest measure of money supply which includes:

    • Bank Reserves (not used for transactions)

    • Currency (paper and coins)

  • 2. M1 Money Supply:

    • Includes:

    • Currency

    • Checkable deposits (like checking accounts)

    • Savings deposits

    • Represents money effectively used as a medium of exchange in the economy.

  • 3. M2 Money Supply:

    • Broader measure that includes all of M1 and additional forms of money that can be easily converted into cash:

    • Small time deposits (like certificates of deposit)

    • Money market mutual funds.

Visualization of Money Supply**

  • Venn Diagram Explanation:

    • Monetary Base includes:

    • Bank Reserves (not part of M1)

    • Currency

    • M1 Money Supply includes:

    • Currency

    • Checkable deposits (not part of the monetary base)

    • Savings deposits (not part of the monetary base)

    • M2 is inclusive of all components in M1 and small time deposits.

Conclusion

  • Overview of the definitions and measures of money covered in this discussion.

  • Encouragement to utilize ReviewEon.com resources for further assistance in economics preparation.

  • Closing remark and invitation for future interactions from Jacob Reed.