Economics Chapter on Money Functions

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What are the three primary functions of money?

Investment, speculation, and consumption

Medium of exchange, unit of account, and store of value (correct)

Liquidity, yield, and capital growth

Credit, equity, and currency fluctuations

Which of the following is NOT considered money according to the economist's definition?

Cash in hand

Gold coins

Stocks and bonds (correct)

Currency notes

How does money differ from other assets?

Other assets have better liquidity than money

Only money serves as a store of value

Money depreciates faster than other assets

Money is regularly accepted for goods and services (correct)

Why are stocks, bonds, and real estate not considered money?

They are not accepted as payment for transactions Signup and view all the answers

Which of the following statements about the functions of money is true?

Money losing value over time affects its function as a store of value Signup and view all the answers

What does the term 'double coincidence of wants' refer to in trade?

The rare occurrence where both parties want what the other offers Signup and view all the answers

How does money facilitate trade in an economy?

It allows individuals to trade goods indirectly Signup and view all the answers

What is one consequence of having money in an economy?

It increases each person's ability to specialize in their best skills Signup and view all the answers

What aspects of money will be discussed in the chapter?

The forms of money and the role of the banking system in creating it Signup and view all the answers

What role does the banking system play in relation to money?

It helps in controlling the production of money and circulation Signup and view all the answers

How does the government influence the money supply?

Through regulation and the control of currency quantity Signup and view all the answers

Which of the following is NOT an economic variable influenced by changes in the quantity of money?

Social behavior Signup and view all the answers

What is the primary benefit of using money over bartering?

Money allows for easier exchange and encourages specialization Signup and view all the answers

What was the primary factor contributing to the acceptance of fiat money according to the content?

Expectations and social convention Signup and view all the answers

What was used as a medium of exchange in Moscow during the 1980s due to a lack of confidence in the ruble?

Cigarettes Signup and view all the answers

Which technological advancement is essential for the operation of cryptocurrencies?

Blockchain Signup and view all the answers

What was the price range of a bitcoin in 2010?

5 cents to 39 cents Signup and view all the answers

Who was the original creator of bitcoin?

Satoshi Nakamoto Signup and view all the answers

What was a significant aspect of bitcoin transactions that attracted users in illicit markets?

Anonymity Signup and view all the answers

Which year did the dollar value of a bitcoin first rise above $1,000?

2013 Signup and view all the answers

Which of the following statements about the price of bitcoin is correct?

Its price peaked at more than $19,000 in 2017. Signup and view all the answers

What does the money supply consist of?

Currency and demand deposits Signup and view all the answers

How does fractional-reserve banking create money?

By lending out a portion of the deposits Signup and view all the answers

What happens to borrowers when banks create money through loans?

They incur debt but gain currency Signup and view all the answers

What is the impact of money creation on the overall economy?

It enhances liquidity without increasing wealth Signup and view all the answers

What is a key characteristic of the loans made by banks in fractional-reserve banking?

They create both assets and liabilities Signup and view all the answers

Which of the following statements is true about the funds in the banking system?

Only a fraction of deposits is kept in reserve Signup and view all the answers

What is the money multiplier if the reserve ratio is 1/10?

10 Signup and view all the answers

How much money is generated by $100 of reserves in this economy?

$1,000 Signup and view all the answers

Why might the creation of money through lending seem miraculous?

It appears that banks create money from nothing Signup and view all the answers

What do loans from banks ultimately provide to the economy?

Greater liquidity as a medium of exchange Signup and view all the answers

If a bank holds $1,000 in deposits with a reserve ratio of 1/10, how much is held in reserves?

$100 Signup and view all the answers

Which formula represents the relationship between reserves and the money multiplier?

Money Multiplier = 1/R Signup and view all the answers

What happens to the money multiplier if the reserve ratio increases?

It decreases Signup and view all the answers

In this imaginary economy, what does the parameter R represent?

The reserve ratio Signup and view all the answers

Which of the following describes how the money multiplier impacts the banking system?

It amplifies the effect of reserves on money creation. Signup and view all the answers

What is the monetary impact when the reserve ratio is set to 1/5?

Each dollar generates $5 of money. Signup and view all the answers

What is considered the most widely accepted medium of exchange in the economy?

Currency Signup and view all the answers

What type of accounts can depositors use to access their money on demand?

Demand deposits Signup and view all the answers

Which of the following can be classified as part of the U.S. money stock?

Currency, checks, and some mutual fund balances Signup and view all the answers

How can depositors access funds in their savings accounts?

By transferring funds to checking accounts Signup and view all the answers

What accounts normally do not allow checks to be written against them?

Savings accounts Signup and view all the answers

Why might demand deposits be considered similar to currency?

They can be accessed on demand through checks and debit cards. Signup and view all the answers

In the context of money stock, how are balances in money market mutual funds treated?

They can be counted if checks can be written against them. Signup and view all the answers

What are personal checks considered in terms of transactions?

An alternative to currency Signup and view all the answers

Study Notes

The Monetary System

When buying a meal, you exchange worthless paper or plastic for a service.
The restaurateur expects to be able to use this same paper or plastic in the future.
This process makes the transactions possible in a large, complex economy.
Money in this context represents a claim to goods and services.

The Meaning of Money

Money is the set of assets that people regularly use to make purchases.
Wealth is not considered money unless it can be exchanged for goods or services.

The Functions of Money

Medium of exchange: Buyers give sellers money for goods and services.
Unit of account: Money measures value. Prices are listed in monetary units.
Store of value: Money can be held for later use for purchasing goods or services.

Commodity Money

Commodity money has intrinsic value.
Example: gold, historically used as money.

Fiat Money

Fiat money has no intrinsic value.
It is determined by government decree.
Example: U.S. paper currency.

Money in the U.S. Economy

Currency (bills and coins) is part of the money supply.
Demand deposits (balances in checking accounts) are also a convenient form of money.
Other assets held in banks, such as savings accounts or money market funds, are part of the money supply as well.
Different measures of the money supply exist, including M1 and M2 (which includes everything in M1, plus other assets).

Banks and the Money Supply

Banks are depository institutions, receiving deposits and holding reserves.
100-percent-reserve banking: Banks hold all deposits as reserves.
Fractional-reserve banking: Banks hold only a fraction of deposits as reserves, used to make loans.
Reserve ratio: The fraction of deposits held as reserves. (e.g., 10 percent)
Money multiplier: Amount money is created with each dollar of reserves (reciprocal of the reserve ratio (1/R)).
A bank also has assets, such as securities and loans, and liabilities, such as deposits and debt.

The Federal Reserve System

The Fed is the central bank of the U.S., regulating the banking system and the money supply.
The Fed's Board of Governors sets monetary policy.
The Federal Open Market Committee (FOMC) is responsible for carrying out monetary policy, primarily through buying or selling bonds (open-market operations).

The Fed's Tools of Monetary Control

Open-Market Operations: Buying and selling bonds to increase or decrease the money supply.
Reserve Requirements: Minimum reserves that banks are required to hold against deposits. Increases in reserve requirements slow money growth.
Discount Rate: Interest rate at which banks borrow money from the Fed. Increasing the discount rate discourages borrowing from the Fed, decreasing money supply.
Interest on Reserves: Interest rate paid on reserves held at the Fed. Increases in interest rates on reserves increase the reserve ratio and slow money growth.

The Federal Funds Rate

The federal funds rate is the overnight interest rate banks charge each other for loans.
The Fed influences this rate through its open-market operations.

Money Growth and Inflation

Inflation is a sustained increase in the overall price level.
Classical Dichotomy: Nominal vs. real variables. Real variables are unaffected by monetary policy.
Monetary Neutrality: In the long run, changes in the money supply affect only nominal variables, not real variables.
The quantity theory of money: The quantity of money determines the value of money (and thus the price level).
Velocity of money: The rate at which money changes hands in the economy.

Costs of Inflation

Shoeleather costs: The costs of reducing money holdings.
Menu costs: The costs of changing prices.
Relative-price variability: Inflation distorts relative prices, hindering resource allocation.
Unexpected inflation: Redistributes wealth arbitrarily, hurting borrowers and benefiting lenders, or vice-versa.

Hyperinflation

Hyperinflation is extreme inflation. Governments finance spending by creating money, leading to rapid price increases.
Often occurs with wartime spending.

The Inflation Tax

The government levies an invisible tax on money holders as prices rise, reducing the purchasing power of money.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

Test your understanding of the primary functions of money and its role in the economy with this comprehensive quiz. Explore essential concepts such as the definition of money, its advantages over bartering, and the impact of banking on the money supply. Dive into the intricate relationship between money and trade.