Monetary System Overview
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Questions and Answers

What is the primary reason money has value in an economy?

  • It is often scarce.
  • It has intrinsic value.
  • It is backed by gold reserves.
  • It is widely accepted as a medium of exchange. (correct)

Which of the following best describes fiat money?

  • Money that is backed by commodities.
  • Money established by government decree. (correct)
  • Currency that fluctuates in value.
  • Money with intrinsic value.

During which era was the gold standard commonly used worldwide?

  • 21st century.
  • 18th century.
  • 20th century.
  • 19th century. (correct)

In the context of the POW camps, what was the role of cigarettes?

<p>They became the established currency for trade. (A)</p> Signup and view all the answers

What is one disadvantage of barter systems highlighted in the POW camp example?

<p>They necessitate a double coincidence of wants. (B)</p> Signup and view all the answers

How is commodity money different from fiat money?

<p>Commodity money has intrinsic value. (A)</p> Signup and view all the answers

What facilitated trade among prisoners in the POW camps despite inefficiencies?

<p>Availability of varied goods from the Red Cross. (D)</p> Signup and view all the answers

What was a common reason for the inefficiency of resource allocation in the POW camps?

<p>Preferences were not considered in allocations. (B)</p> Signup and view all the answers

What is the formula for calculating the money supply, M, based on the monetary base, B?

<p>M = m × B (A)</p> Signup and view all the answers

What is the primary function of banks in a fractional-reserve banking system?

<p>To lend out a portion of deposits and charge interest (A)</p> Signup and view all the answers

What are the three main functions of money?

<p>Store of value, unit of account, medium of exchange (D)</p> Signup and view all the answers

How does money function as a store of value?

<p>It allows individuals to transfer purchasing power for future use. (B)</p> Signup and view all the answers

What is meant by the liquidity of an asset?

<p>The ease with which an asset can be converted into cash. (C)</p> Signup and view all the answers

Why is a barter economy considered limited compared to a monetary economy?

<p>It requires a double coincidence of wants for exchanges to occur. (B)</p> Signup and view all the answers

What was the role of cigarettes in the POW camp?

<p>They became a store of value, unit of account, and medium of exchange. (B)</p> Signup and view all the answers

What is required to open a bank?

<p>Bank capital from owners. (C)</p> Signup and view all the answers

What is a characteristic of fiat money as described in the content?

<p>It is accepted based on social convention. (C)</p> Signup and view all the answers

What is the role of money as a unit of account?

<p>It provides a standard measure for quoting prices and recording debts. (B)</p> Signup and view all the answers

What was the government’s initial role in the evolution of currency?

<p>To mint gold coins to reduce verification costs. (B)</p> Signup and view all the answers

Which of the following best describes the statement 'This note is legal tender for all debts, public and private'?

<p>It underscores the universality of money as a medium of exchange. (B)</p> Signup and view all the answers

Why did gold-backed government bills become widely accepted over time?

<p>Everyone expected others to value them. (A)</p> Signup and view all the answers

What is one reason people hold money despite it not being a perfect store of value?

<p>It is universally accepted for future transactions. (C)</p> Signup and view all the answers

How did the function of money change from commodity money to fiat money?

<p>The physical backing of money became irrelevant. (D)</p> Signup and view all the answers

Which of the following highlights the complexities of transactions made possible by money?

<p>Utilizing money to facilitate diverse economic exchanges. (D)</p> Signup and view all the answers

What is a common misconception about commodity money described in the content?

<p>It has inherent value without any social agreement. (A)</p> Signup and view all the answers

What complication did people face when using raw gold as money?

<p>It required time-consuming verification for quality and quantity. (B)</p> Signup and view all the answers

What ultimately leads people to value fiat money?

<p>The expectation that others will also value it. (C)</p> Signup and view all the answers

Flashcards

Commodity Money

A system where a good with intrinsic value, like gold, is used as currency.

Fiat Money

A system where a currency's value is not based on its intrinsic value but on government decree or trust.

Medium of Exchange

The ability of a good to be exchanged for other goods and services.

Unit of Account

The role of a currency in representing value.

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Store of Value

An item that retains its value over time.

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Transaction Costs

The time and effort spent verifying the quality and quantity of a commodity.

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Gold Certificates

Pieces of paper issued by the government that can be exchanged for a fixed amount of gold.

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Evolution of Money

The process of shifting from a commodity-based money system to a fiat money system.

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Money Supply

The total amount of money in circulation within a country's economy, held by individuals and businesses.

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Liquidity

The ability of an asset to be easily exchanged for goods or services.

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Barter Economy

A system of exchange where goods and services are traded directly for other goods and services, without using money.

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Double Coincidence of Wants

An economic concept where two individuals possess goods that each other wants at the same time and place, making a direct barter exchange possible.

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Inflation

The rise in the general level of prices for goods and services within an economy over time.

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Fractional-Reserve Banking

The practice where banks keep only a fraction of their deposits in reserve, while lending out the rest.

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Reserve-Deposit Ratio

The ratio of a bank's reserves to its deposits. It represents the percentage of deposits held in reserve.

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Money Creation

The process by which banks create new money by lending out a portion of their deposits.

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Deposits

Deposits held by a bank that are available for withdrawal by depositors.

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Reserves

Assets that banks hold to meet depositors' withdrawal demands. This includes cash and reserves held at the central bank.

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Loans

The amount of money a bank lends out to borrowers. This includes loans for homes, businesses, etc.

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Money Creation Process

The process by which money moves between banks as borrowers deposit loan proceeds into other banks, continuing the money creation process.

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Barter System

A system where goods and services are exchanged directly for other goods and services, without the use of money.

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Gold Standard

A system where the currency is backed by gold, meaning it can be exchanged for a fixed amount of gold.

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Differing Tastes and Endowments

The situation where different individuals have different preferences for goods, leading to the need for exchange.

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Trade

The process of exchanging goods and services, often involving multiple parties and facilitated by money.

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Economy Using Money

A system where prices are expressed and transactions occur using a common medium of exchange.

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Bank Capital

The resources that bank owners provide to start the business. It is also referred to as the equity of the bank's owners.

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Leverage Ratio

The ratio of a bank's total assets to its capital. It shows how much of a bank's assets are financed by borrowed money.

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Leverage

The use of borrowed money to supplement existing funds for investment purposes. This allows banks to multiply their investments with a smaller initial capital.

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Securities

A bank's financial assets like government or corporate bonds. These are investments that generate returns for the bank.

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Bank Loans

Loans extended by a bank to borrowers. This is the primary source of income for a bank.

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Debt

Funds borrowed by the bank from investors. It is a source of financing for a bank.

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Money supply (M)

The total amount of money in circulation in an economy, including currency and demand deposits.

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Monetary base (B)

The portion of the money supply directly controlled by the central bank, consisting of currency in circulation and commercial bank reserves at the central bank.

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Reserve-deposit ratio (rr)

The ratio of commercial bank reserves to deposits. A higher reserve ratio means banks hold more reserves and lend less.

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Currency-deposit ratio (cr)

The ratio of currency held by the public to their deposits. A higher currency ratio means people hold more cash and less money in bank accounts.

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Money multiplier (m)

The ratio of the money supply (M) to the monetary base (B). It measures the extent to which the money supply is multiplied by the banking system.

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Credit creation

The process by which commercial banks create new money through lending. When banks make loans, they create new deposits, expanding the money supply.

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Monetary policy

An action taken by the central bank to influence the money supply and interest rates. Common tools include open market operations, reserve requirements, and the discount rate.

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Open market operations

The purchase or sale of government bonds by the central bank to influence the money supply. Buying bonds injects money into the economy, while selling bonds removes money.

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Study Notes

Monetary System

  • Macroeconomic policy has two main components: monetary and fiscal policy.
  • Fiscal policy involves government decisions on spending and taxation.
  • Monetary policy focuses on the nation's coin, currency, and banking system.
  • Central banks, like the Federal Reserve, make monetary policy decisions.
  • These institutions heavily influence people's lives and livelihoods.

What is Money?

  • Money is a specific type of wealth, used for transactions.
  • Three key functions of money are:
    • Store of value: transfers purchasing power through time.
    • Unit of account: a standardized way to quote prices and record debts.
    • Medium of exchange: facilitating transactions.

Types of Money

  • Fiat money: established as money by government decree. Examples include US dollars.
  • Commodity money: has intrinsic value, most commonly gold.
  • Example of commodity money, cigarettes were used as money in POW camps.

The Role of Banks

  • 100% reserve banking: banks hold all deposits as reserves, no lending, money supply unchanged.
  • Fractional reserve banking: banks hold a fraction of deposits, lend rest, money supply increases.
  • Banks create money through lending. Depositing money in a bank creates a loan in the same amount and so money creation happens further increasing the money supply.

How the Quantity of Money is Measured

  • Currency (cash)
  • Demand deposits (checking accounts and similar accounts)
  • M1 and M2 are common measures—M1 being a narrow definition, containing currency, demand deposits and similar accounts, whereas M2 includes M1 plus savings.

How Central Banks Influence the Money Supply

  • Open market operations: When the Federal Reserve buys bonds, it increases the money supply, and vice versa.
  • Reserve requirements: regulations that impose a minimum reserve-deposit ratio on banks. This changes the money multiplier, affecting money supply.
  • Discount rate: The interest rate Fed charges on loans to banks; lower rates encourage borrowing, increasing money supply.
  • Interest rate on reserves: When the central bank increases the interest rate it pays on reserves, banks hold onto more reserves than they lend out, reducing the money multiplier and lowering the money supply
  • Quantitative easing: buying long-term government bonds increasing the monetary base.

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Related Documents

Chapter 4 The Monetary System PDF

Description

Explore the fundamentals of the monetary system, including the roles of monetary and fiscal policy. Learn about different types of money, their functions, and the influence of central banks on the economy. This quiz delves into the essential elements that shape financial transactions and banking practices.

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