7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 1/31

11

Chapter 2

Money: Its Nature,

Functions, And Evolution

©Thomson/South-Western 2006

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 2/31

22

The Nature And Functions Of Money

Money is anything that is generally acceptable aspayment for goods and services or for thesettlement of debt.

Coins, paper bills, etc.

Acceptance is contingent on confidence that it willretain its value or purchasing power.

Confidence in money’s value relies on it being

sufficiently scarce that its value does not diminishover time.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 3/31

33

Historical Money

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 4/31

44

Economists’ Definition of Money 

all currency (coins and paper bills) held by the public

demand deposits and other checking deposits in:

commercial banks,

savings and loan associations,

mutual savings banks, and

credit unions

Practically all payments are made by the exchangeof currency or by the transfer of deposit balances viachecks or electronic (wire) transfer.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 5/31

55

Legal Tender

Legal tendercannot lawfully be refused in payment for goods andservices and for discharge of debts.

no merchant or creditor can demand payment in another

form.Only Currency and coins are legal tender.

Checking accounts are not legal tender.

Many items have served as money without havinglegal tender status.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 6/31

66

Why Credit Cards Are Not Money

Credit cards are essentially a method of postponing paymentfor a few days or months.

The cards themselves do not constitute money.

Actual money payment is merely deferred until later.

Credit cards do not influence the supply of money, but do

reduce the demand for money.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 7/3177

Distinctions Among Money, Wealth, & Income

Though money, income and wealth are all measured in“dollars;” they differ significantly in their meaning.

People have ______ if they have large amounts of currency or

big bank accounts at a point in time. (stock variable)

Someone earns ______ from work or investments

over a period of time. (flow variable)People have ______ if they have assets > debts

at a point in time. (stock variable)

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 8/3188

3 Functions of Money

Money serves as a

1.  medium of exchange or means of payment  

2. standard of value or unit of account 

3. store of value 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 9/3199

1. Medium of Exchange

A barter economy is one in which goods andservices are traded directly for one another.

In barter economy, people must find producers of what

they want who also want what they have to trade.

This double coincidence of wants is socially inefficient,and the introduction of money eliminates this problem.

In a money economy, people use money to sell theirgoods or services for money and buy what theywant with money.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 10/311010

2. Standard of Value (Unit of Account)

Money serves as a measuring rod or yardstick to assessthe relative value of various goods and services.

Without money, each item brought to market would bear

a certain value relative to each of the other items--e.g.good A, B, C, and D.

With money, each good has one price (in dollars).

In a society with N goods, there are:

N prices when money works.

N(N-1)/2 prices when barter predominates.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 11/311111

3. Store of Value

Money acts as a temporary storage of purchasing power. 

In a barter economy, the purchase of any item implies asimultaneous sale of another item.

In a money economy, people can sell something (e.g. theirlabor) without buying something simultaneously.

Money is not the only store of value.

Money is not a perfect store of value.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 12/311212

Liquidity

“ The relative ease with which an asset can be converted into money (i.e., liquidated) without significant commissions, other 

charges, inconvenience and risk of  principal”  

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 13/311313

Liquidity (2)

We store purchasing power as money rather than assomething else because converting it back intomoney can be costly.

An asset is liquid if it can be easily converted intomoney and illiquid if it is costly to convert.

Cash is perfectly liquid.

Stocks and bonds are somewhat less liquid.Land is illiquid.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 14/311414

Inseparability of the Store-of-Value &Medium-of-Exchange Functions

During hyperinflation, individuals and firms franticallyattempt to rid themselves of money because its value

was deteriorating rapidly—that is, money failed as a

store-of-value

Merchants may refuse to accept payment in money,

insisting instead on payment in goods and services—this

reflects money’s failure as a medium-of-exchange

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 15/311515

Evolutions of Money

1. Full-bodied or Commodity Money

2. Representative Full-Bodied Money 3. Fiat or Credit Money

 4. Checking Accounts 5. Electronic Money 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 16/31

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 17/311717

1. Full-bodied or Commodity Money (2)

If coins are worth more for their metal than for their exchange

value, then they will be melted down or milled off.

If metal is worth more as coins than it is as a commodity,

then it will be turned into coins unless regulation preventssuch minting.

The forces of supply and demand ensure that the value of the

coin will not deviate markedly from its value as a commodity.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 18/311818

2. Representative Full-Bodied Money

During the industrial revolution, the exclusive use of

coins as medium of exchange became increasingly

inconvenient.

Coins were supplemented with paper currency that

was backed by the valuable metals. 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 19/311919

3. Fiat or Credit Money

Does money need to be backed by a commodity at all? 

The logical answer to this question is no

If the monetary system is stable and functions effectively,

“backing” is expensive, inconvenient, and unnecessary.

Today, money is only backed by confidence that government will responsibly limit the quantity of money toensure that money in circulation will hold its value.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 20/31

2020

3. Fiat or Credit Money (2)

“Form of money that derives its value by fiat

or government decree rather than throughits value as a commodity” 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 21/31

2121

Advantages and Disadvantages of Fiat Money

AdvantagesFewer resources are used to produce money.

The quantity of money in circulation can be

determined by rational human judgment ratherthan by discovering further mineral deposits—like gold or diamonds.

Disadvantage:A corrupt or pressured government mightissue excessive amounts of money,

Causing inflation.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 22/31

2222

4. Checking Accounts

Advantages:People are not forced to carry around large amounts ofpaper currency.

You can pay bills without worrying about the cash being

stolen in transit.Accounts are insured up to $100,000.

Checks provide records for accounting & tax purposes

DisadvantagesCheck clearing costs $5 billion per year.

Checks must “clear”—introducing “float” costs.

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 23/31

2323

5. Electronic Money

Innovations in data processing, information retrieval,and communications systems make electronicmoney systems possible.

Advantages Efficiency

Reduced cost of processing checks

Reduced costs from billing credit cards

Employers can reduce their payroll costs by paying with

direct deposit.People can reduce their costs by paying bills electronically

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 24/31

2424

Newer Electronic Money

Debit cards

Stored-value cards

Electronic checks

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 25/31

2525

Debit cards

A card with which an individual pays for an item by transferring funds 

electronically and immediately from his / her bank account to the merchant’s bank 

account 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 26/31

2626

Stored-value cards

Cards loaded with a predetermined amount 

of money; used to make payments 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 27/31

2727

Electronic cash

E-cash

Form of money that facilitates payment for

items purchased over the Internet

An individual sets up a bank account in whichthe bank transfers e-cash to the individual’s

personal computer via the Internet

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 28/31

2828

Electronic checks

Similar to regular checks except that the

process is electronic, circumventing the

costly procedure of physically processingand transporting checks.

Lower cost relative to traditional paper

checks

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 29/31

2929

Factors Slowing the Transition to ElectronicMoney

High fixed technology costs

No physical receipts and transaction records.Have to pay immediately (for payer), compare towriting checks.

Legal and security concerns regarding theft andloss of privacy

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 30/31

3030

Measures of Money Supply

Money supply influences output, income, and prices.

Accurate measures of money supply must be

tabulated and published regularly.

Industrial nations employ fairly standard measures

of money.

The U.S. Federal Reserve currently publishes data onseveral “monetary aggregates” (M1, M2, and M3). 

7/31/2019 Fin2700 Ch02 a Toi Ppt

http://slidepdf.com/reader/full/fin2700-ch02-a-toi-ppt 31/31

M1, M2 and M3

M3 = M2 + Large (>$100K) Time Deposits +Repurchase Agreements +

Money Market Mutual Fund Shares (held by institutions)

M2 = M1 + Savings Accounts +

Money Market Deposit Accounts (MMDA) +

Small (<$100K) Time Deposits +

Money Market Mutual Fund Shares (held by individuals)

M1 =

Currency +

Demand Deposits + Travelers’ Checks 

+ Other Checkable Accounts