Economics: Money, Spending, Saving, and Borrowing

Defining Money and its Historical Context

  • Definition of Money: Money is defined as any agreed commodity that can be used as a medium of exchange specifically for the purchase of goods and services.

  • Temporal Development: The concept of 'Money' has not remained stagnant; it has developed significantly over time. Money as it is recognized today has not always existed.

  • Pre-monetary Systems: Before the invention and adoption of standardized money, humans had to rely on alternative methods for survival and trade:     - Self-sufficiency: Individuals or groups produced everything they needed for their own consumption.     - Barter: A system of direct exchange.     - Maori Customs:         - Utu: The practice of reciprocation for kind deeds.         - Koha: The tradition of giving gifts.

The Barter System and its Inherent Issues

  • Definition of Barter: Bartering is the process of exchanging goods and services directly for other goods and services.     - Example: Swapping a shell for a goat.

  • The Fundamental Problems of Barter:     - Double Coincidence of Wants: This is the primary requirement for a barter trade to occur; one person must possess something the other person desires, and vice versa, at the exact same time.     - Measurement of Value: There is no standardized unit to measure how much one item is worth relative to another.         - Hypothetical Scenario: If you need a house but only have goats to trade, how many goats are equivalent to a house? Furthermore, it is difficult to find a builder who specifically needs the exact number of goats required to justify building an entire house.     - Perishability: This issue arises when the items used for exchange are biological or food-related. If a person only has food to exchange, the trade must happen before the food goes off. A poor crop or spoiled goods result in a total loss of trading power.     - Subjectivity of Value: The value of goods and services is often subjective and differs from person to person. Without a standard, agreeing on a fair value is extremely difficult.

Transition to Commodity Money and its Characteristics

  • Early Solutions: To solve barter issues, people began using common items that held some level of intrinsic value, such as knives, beads, or shoes. While people were willing to accept these in exchange for other items, they lacked the essential characteristics required for a functioning currency.

  • The Five Essential Characteristics of Money:     - Universal Acceptability: Everyone within the economy must agree to accept the medium as money for it to function.     - Divisibility: Money must be capable of being divided easily into smaller units to allow for different price points.         - Logic: If an item is priced at "half," you cannot simply cut a goat in half. This is why modern currency has different values for notes and coins.     - Portability: Users must be able to carry the money around with them easily for transactions.     - Durability: The material must be reasonably hard-wearing, able to stand the test of time, and not be easily ruined under various environmental conditions.     - Scarcity: For anything to maintain value, it must be in limited or scarce supply.

The Evolution of Coins and Paper Currency

  • Development of Metallic Coins: Using the essential characteristics, coins made of gold and silver were developed. The value was backed by the fact that each coin weighed a specific amount and consisted of pure precious metal.

  • Problems with Metallic Coins:     - Skimming/Shaving: Individuals would shave small pieces off the edges of coins to create extra coins while claiming the original coins still held their full value. This was possible because digital accurate scales did not exist at the time.     - Weight and Portability: While coins improved portability compared to livestock, they were still heavy in large quantities.

  • The Rise of Paper Money: As banking systems progressed, paper money was issued. This paper could be taken to a bank and exchanged for physical gold.

  • Initial Lack of Centralization: In the early stages of paper currency, there was no central bank. Consequently, many different versions of paper money were in circulation simultaneously.

The Four Key Functions of Money

  • Medium of Exchange: Any item that is widely acceptable in exchange for goods and services. In modern economies, currency is the most common medium of exchange used.

  • Measure of Value: Money acts as a standard unit that allows individuals to compare the relative values of different products.

  • Store of Value: Money can be saved or stored and spent at a later date while retaining its value. This provides individuals with flexibility regarding the timing of their spending.

  • Means of Deferred Payment: Money facilitates "buy now, pay later" schemes or the accumulation of debt. This is possible because the seller accepts that the money received in the future will hold the same relative value as it does today.

Understanding the Money Supply

  • Categorization as a Commodity: Money is an accepted medium of exchange and is often classified as a commodity because it must store value.

  • Components of Money Supply: The total money supply is comprised of:     - Physical Notes.     - Physical Coins.     - Bank Deposits.     - Assets in other financial institutions.

  • Liquidity and Value: Determining what exactly counts as money is complex. While cash is universally accepted, it can lose value over time. Financial assets like property or shares can be considered a form of money because they store value and are "liquid" (they can be converted into cash to make payments).

  • Modern Money Statistics:     - Physical cash represents only approximately 8−9%8-9\% of the total modern money supply. The remainder is digital or held in financial assets.     - In New Zealand (NZ), the money supply consisting of coins, notes, and very liquid assets was approximately $7b\$7b.

Definitions of Core Economic Behaviors

  • Spending: The act of purchasing goods and services to satisfy specific needs and/or wants.

  • Saving: The act of delaying consumption by holding onto a portion of one's income to be utilized at a future date.

  • Borrowing: The act of obtaining money from a bank, financial institution, or person with the intent to use it for a specific purpose, usually involving a commitment to repay.

  • Disposable Income: The specific amount of money an individual has remaining to either spend or save after all necessary payments and taxes have been deducted.

Hypothetical Financial Planning: The 100,000100,000 Prize Example

  • Scenario: If a person won a prize of $100,000\$100,000, a breakdown of usage (using Mr. Crooks' 20222022 example) might look like:     - Long-term Savings: $50,000\$50,000 placed into a long-term savings account.     - Investment: $20,000\$20,000 placed into investment funds.     - Consumption/Holiday: Between $5,000\$5,000 and $10,000\$10,000 for a two-week summer holiday.     - Consumer Goods: Purchasing new golf clubs.     - Gifts: Purchasing jewellery for a partner.     - Miscellaneous: The remainder used for rough spending.

Factors Influencing Spending, Saving, and Borrowing

  • Income Changes:     - Increase in Income: Typically leads to an increase in spending, an increase in saving, and an increase in borrowing (as people feel better off and more capable of managing debt).     - Decrease in Income: Typically leads to a decrease in spending, a decrease in saving, and a decrease in borrowing as people are financially worse off.

  • Direct Tax Changes:     - Increase in Direct Tax: Reduces disposable income. This leads to a decrease in spending and saving. Borrowing may increase for some trying to maintain their lifestyle, or decrease for others.     - Decrease in Direct Tax: Increases disposable income, leading to an increase in spending and saving, with varying effects on borrowing.

  • Interest Rate Changes:     - Increase in Interest Rates: Leads to a decrease in spending and borrowing (as debt becomes more expensive) and an increase in saving (as the return on savings at the bank is higher).     - Decrease in Interest Rates: Leads to an increase in spending and borrowing (as it is cheaper than before) and a decrease in saving (as the return is less attractive).

  • Availability of Saving Schemes:     - High Availability: Encourages more saving, leading to a decrease in spending and borrowing.     - Low Availability: If there are fewer ways to get a good return on savings, people often spend and borrow more.

  • Availability of Credit:     - High Availability: Cheap and easy access to credit cards and loans encourages increased debt (borrowing) and spending, while decreasing saving.     - Low Availability: When loans are harder to get and more expensive, spending and borrowing decrease while saving increases.

  • Consumer Confidence:     - High Confidence: If the economy is perceived as stable or growing, people are more willing to buy things and borrow money.     - Low Confidence: If people fear a recession, they may increase saving to prepare for the future (such as potential job losses) while decreasing spending and borrowing.

Demographic and Life Stage Impacts

  • Age and Experience: As individuals age, they gain experience which often correlates with higher levels of income.

  • Saving Trends: Older individuals may transition into saving more as they prepare for the future.

  • Youth Spending: Younger people tend to spend a higher proportion of their income on immediate "wants" like dinner and music festivals.

  • Family Life Cycle: Those starting families typically experience increased spending and borrowing for needs related to children and purchasing a home.

COVID-19 Economic Data

  • NZ Consumer Spending Impact: Consumer spending in New Zealand saw a notable decline during the pandemic. In the second quarter of 20212021, spending was at 4355243552 NZD Million. By the third quarter of 20212021, this figure dropped to 4036340363 NZD Million.

Questions and Discussion

  • Past Paper Question (a): Explain the difference between saving and borrowing. [44 marks]     - Answer Key:         - Saving is income minus spending (putting money in the bank), whereas borrowing is money obtained from a lender.         - Saving involves spending less than one's income; borrowing means spending more than one's income.         - Savings increase personal wealth; borrowing increases personal debt.         - Savings earn interest for the individual; borrowing incurs charges or interest payments to the lender.         - Savings allow for spending in the future; borrowing allows for spending immediately.

  • Past Paper Question (b): Analyse the impact of a cut in interest rates on saving and investment. [66 marks]     - Answer Key:         - Impact on Saving: When interest rates are reduced, saving is expected to fall because the return on saving decreases. The opportunity cost of spending is reduced, causing individuals to spend more and borrow more.         - Impact on Investment: Investment is expected to rise because it becomes cheaper for firms to borrow money. This reduces the cost of investment and makes business projects more profitable than they were previously.