Role of Money in Modern Economics

1454 Words Oct 20th, 2012 6 Pages
Chapter11: Money, Banking & the Financial Sector

I. Money
A. Money is defined as anything people accept for goods and services. In modern economies, money is national currency.
B. In the absence of money, societies use a “barter” system in which goods are exchanged for goods.
1. Barter economies require a “Double Coincidence of Demand” in that the two market participants must each be supplying what the other demands.
2. Barter also implies negotiations over the exchange (a cost modern economies often avoid), which have the economic cost of the time spent for each purchase an individual makes.
C. In a more Modern System, paper currency is the means of exchange. Society’s acceptance of it for goods and services gives money its value.
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This type of certificate of deposit is denominated in units such as $100,000, is negotiable for resale, and cannot be withdrawn against by check writing.

Credit cards are only a method of borrowing money, and are not added into the calculation of money supply.

From M1 to the large value CDs in M3, liquidity has changed drastically. Liquidity is how close a given account is to money, a means of making an immediate purchase. Near monies are highly liquid.

4. The book also mentions L as a broad measure of money where L includes M1, M2, and short-term debt instruments (less than 1-year to maturity).

I. Banking involves a “fractional reserve principle,” meaning only a small percentage of demand deposits actually has to be on hand all the time, because banks do not have all accounts being used up simultaneously. This enables banks to make loans and grow the overall money supply.

J. Electronic exchange systems, and primarily the debit card, have partially offset the need for people to carry currency, or write checks. Still, many suppliers of goods and services take only cash, and debit cards do not eliminate the possibility of theft and fraud.

III. Required Reserves and the Money Multiplier

A. Imagine the only bank in an economy has Assets and Liabilities listed below:
Monopoly Bank
Assets Liabilities
Reserves $25,000 Deposits $100,000
Loans $75,000
B. Required Reserve Ratio (RRR or just r):