Introduction to Money - In-Depth Notes

Learning Objectives

  • By the end of this lecture, students should be able to:

  • Develop precise definitions of money and its key characteristics.

  • Explain the primary functions of money and how it promotes economic efficiency.

  • Trace the historical development of money and its changing forms over time.

  • Understand how money is measured and classified in the economy.

Meaning of Money

  • Money: Anything that is generally accepted in payment for goods or services or in repayment of debts.

  • Difference between Money, Wealth, and Income:

  • Wealth: Total collection of pieces of property that serve to store value.

  • Income: Flow of earnings per unit of time.

Functions of Money: Medium of Exchange

  • Function #1: Medium of Exchange

  • In a barter economy, goods and services are exchanged directly leading to inefficiencies due to the complexity of finding a double coincidence of wants.

  • Economic Efficiency: Money minimizes transaction costs and promotes specialization and division of labor.

Characteristics of Money as a Medium of Exchange

  • Criteria for a commodity to function as money:

  1. Easily standardized.

  2. Widely accepted.

  3. Divisible for making change.

  4. Easy to carry.

  5. Does not deteriorate quickly.

Functions of Money: Unit of Account

  • Function #2: Unit of Account

  • Measures value in the economy; prices expressed in terms of money (e.g., a shirt costs N3000).

  • Reduces transaction costs by simplifying price considerations, especially as the economy grows complex.

Functions of Money: Store of Value

  • Function #3: Store of Value

  • Money saves purchasing power over time but is not the only store of value (other assets like stocks, bonds, real estate exist).

  • Liquidity: Money is the most liquid asset as it requires no conversion to make purchases.

  • Inflation and Value: Money loses value during inflation, making assets more appealing during high inflation periods (e.g., hyperinflation).

Evolution of the Payment System

  1. Commodity Money: Made from precious metals or commodities; standardized and acceptable but difficult to transport and divide.

  2. Paper Currency: Initially convertible to precious metals, now fiat money mandated by governments; advantages include ease of transport and divisibility but requires trust.

  3. Cheques: Instructions for money transfers; reduce transport costs but take time to clear.

  4. Electronic Payments and E-Money: Instant transactions with records; low cost but initial system costs and safety/privacy concerns.

Measuring Money

  • Money Supply (Money Stock): Sum of all money or monetary assets that can quickly convert to cash; influenced by country and development level.

  • Monetary Aggregates in Nigeria:

  • M0: Currency outside banks + central bank reserves.

  • M1: All currencies in circulation + demand deposits.

  • M2: M1 + near money (savings and time deposits).

  • M3: M2 + other near moneys like government treasury bills.

Summary of Monetary Aggregates

  • M0: Most liquid measure, controlled by the central bank.

  • M1: Includes demand deposits, usable for payments.

  • M2: Expands on M1 to include savings accounts.

  • M3: Broadest measure, including treasury bills held by sectors.