Financial Sector: Definition and Measurement of MoneyAP MacroEconomics

Mr. Bordelon

You’re so money, baby,and you don’t even know it!

Money. Any asset that can easily be used to purchase g/s. Money eliminates the need for bartering.

But what’s the point of money? Money serves certain roles: Medium of exchange

Store of value

Unit of account

Roles of Money

Medium of exchange. Asset that individuals acquire for the purpose of trading g/s rather than for their own consumption. Accepting currency as a medium of exchange eliminates the need

for barter.

If our currency was chicken, you’d have to buy a cup of coffee with a chicken. Chickens are inconvenient to carry around. A dollar on the other hand, is much easier, cleaner, and less likely to give you bird flu.

Roles of Money

Store of value. Means of holding purchasing power over time. If chickens are currency, it’s kind of hard to tell

whether one chicken is actually one chicken from one day to the next. Chickens lose and gain feathers. Chickens die. Chickens aren’t smart, they thought they could fly, but chickens couldn’t fly, they DIE DIE. They’re the chickens who DIE DIE!

But it’s a good bet that $1 bill will equal $1 yesterday, today, tomorrow, and in the future, at least conceptually. It’s durable, divisible, and lacks chicken blood.

Roles of Money

Unit of account. Measured used to set prices and make economic calculations. We’re not only talking the numerical value here, but also the

actual unit of currency: dollars, pounds, euros, etc.

Sorry, I’m out of chicken jokes. Except that it’s tough to make change out of a chicken, and eggs don’t count.

Types of Money

• Commodity money. Good used as a medium of exchange that has intrinsic value in other uses. In other words, the commodity that the money is made from is worth something in and of itself.

▫ Gold, silver, copper typically have been the commodities used.

▫ Generally, a bad idea. If the commodity is worth more than the currency, people will take the commodity instead of the cash, and melt it down. This takes money out of circulation.

Types of Money

Commodity-backed money. Medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods.Commodities have value. What if you could

create a dollar bill whose worth is based on gold? That’s the idea of commodity-backed money. Once upon a time, you could actually exchange the dollar for it’s amount in gold.

Problem is if the commodity loses value, so does the money. And this is what happened in the stock market crash of 1929. Once gold lost its value, so did the U.S. dollar.

Types of Money

Fiat money. Medium of exchange whose value derives entirely from its official status as a means of payment. In this case, money is money because the government says it is.

This is the basis for the modern financial system. It’s based on the sovereign right of seigneurage, the right to coin money.

Types of Money

Special note on fiat money. Fiat money is the way money is made today, because the U.S. government says so, and the full faith and credit of the U.S. government, through its central bank of the Federal Reserve is enough.

We are NOT on the gold standard. I will raise hell upon high, I will make the seas boil, the earth quake, and unleash plagues upon your ancestors and all the earth, the eighth seal will be broken and there will be a silence in heaven for about 30 seconds if ANY OF YOU ever state that we are. Grrrr.

How Much Money is Out There?

You can measure money.

Rephrase: You must be able to measure the money supply in order to pass the AP Macroeconomics exam.

Monetary aggregate. Overall measure of the money supply.

Two measurements: M1 and M2.

M1

M1 is a measurement of liquidity. M1 is limited to Currency in circulation

Checking accounts

Traveler’s checks

M2

M2 is a measurement that includes liquidity and near moneys (assets that can’t be directly used as a medium of exchange but can be converted into cash/checking deposits). M1

Savings accounts

Money market accounts

Certificates of Deposits (CDs)