1 understanding economics chapter 13 money copyright © 2005 by mcgraw-hill ryerson limited. all...
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1
Understanding Economics
Chapter 13Money
Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
3rd editionby Mark Lovewell, Khoa Nguyen and Brennan Thompson
2Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
In this chapter, you will:1. examine the functions of money, its
components, and the various definitions of money
2. learn about the demand for and supply of money and about equilibrium in the money market
3. see how money is created and consider the money multiplier
3Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Functions of Money There are three main functions that money performs
• a means of exchange (it overcomes the need for barter) Without money, market participants must trade
one product for another product, a transaction known as barter.
• a store of purchasing power Money’s major advantage is its liquidity, or the
ease with which it can be turn into a means of payment.
• a measure of value Money provides buyers and sellers with a unit of
account, or pricing standard that allows all products to be valued consistently.
4Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Canadian Financial System
The supply of money is closely associated with institutions known as deposit-takers.
Deposit-takers• accept funds provided by savers and lend these
funds to borrowers Deposit-takers also keep on hand some
amount, known as cash reserves• hold cash reserves to meet the needs of
depositors withdrawing funds
5Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Canadian Financial System
The four traditional pillars of the Canadian financial system were• chartered banks:• trust companies• insurance companies• investment dealers
Financial deregulation is allowing institutions in each pillar to perform a wider range of functions
6Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Chartered Banks and Near Banks
Chartered banks are deposit-takers allowed by federal charter to offer a wide range of financial services
Near banks are deposit-takers that are not chartered and have more specialized services• trust companies: administer various types of
accounts, including estates and trust funds and also compete with chartered banks by taking deposits and granting loans mainly to household.
• mortgage loan companies: specialize in granting mortgages and raise some of their funds through deposit-taking,
• credit unions and caisses populaires
7Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Chartered Banks and Near Banks in Canada Figure 13.1, Page 313
(total assets, $ billions, 31 July 2002)
Chartered Banks Near Banks
Trust and mortgageloan companies $ 10.2
Credit unions andcaisses populaires 134.1
Total $144.3
RBC $ 377.7Scotiabank 296.4TD 278.0CIBC 273.3BMO 252.9National 74.6Others 135.6
Total $1688.5
8Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Components of the Money Supply (a)
There are various possible components of the money supply• currency includes notes and coinage• demand deposits are funds to which depositors
have immediate access• notice deposits are funds for which deposit-takers
may require notice for withdrawals• term deposits are funds to which depositors have
no access for a fixed period• foreign currency deposits are funds held by
Canadian residents that are valued in foreign currency
9Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Money Defined (a)
There are four common definitions of money in Canada• M1 includes currency outside chartered banks
and publicly held demand deposits at chartered banks
• M2 consists of M1 plus notice deposits and personal term deposits at chartered banks
• M3 consists of M2 plus nonpersonal term deposits and foreign currency deposits at chartered banks
• M2+ consists of M2 plus corresponding deposits at near banks and some other liquid assets
10Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Canadian Money SupplyFigure 13.2, Page 315
0
100
200
300
400
500
600
700
800
900
M1 M2 M3 M2+
Money Definition
$ B
illio
ns (
Oct
ober
200
2)Near Bank Deposits andOther Liquid Assets
Other Chartered BankDeposits
Chartered Bank Noticeand Personal TermDeposits
Chartered Bank DemandDeposits
Currency OutsideChartered Banks
141
563
756806
57%
75%57%
26%29%
52%
18% 13% 13%
43% 7% 5% 5%
11Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Choosing a Definition (a)
Some economists believe that M1 is the most accurate definition of the money supply
Other economists prefer M2 or M2+ especially because of recent innovations in payments methods• credit cards make it more convenient for
purchasers to use deposits for payments purposes by borrowing funds for short periods
• debit cards add to the convenience of using deposits for payment purposes by allowing funds to be electronically moved from these deposits
12Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Money Demand (a)
There are two types of money demand• transactions demand is related to
money’s use as a means of exchange and varies directly with real output and the price level
• asset demand is related to money’s use as a store of purchasing power and is inversely related to the nominal interest rate
13Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Money Demand and Money Supply
Money demand• represents the amounts of money
demanded (for both transactions and asset demand purposes) at all possible interest rates
• is represented by a schedule or curve Money supply
• is a set amount determined by government decision-makers
• is represented by a schedule or curve
14Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Demand for MoneyFigure 13.3, Page 320
Money Demand Curve
0 10 20 30 40 50 60 70 80
1
2
3
4
5
Quantity of Money ($ billions)
Nom
inal In
tere
st R
ate
(%
)532
405060
506070
Money DemandSchedule
NominalInterest
Rate(%)
Quantityof Money
Dm0 Dm1
($ billions)
Dm0 Dm1
15Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
The Supply of MoneyFigure 13.4, Page 320
Money Supply Curve
0 10 20 30 40 50 60 70 80
1
2
3
4
5
Quantity of Money ($ billions)
Nom
inal In
tere
st R
ate
(%
)Money SupplySchedule
NominalInterest
Rate(%)
QuantityOf Money
Sm0 Sm1
($ billions)
532
505050
606060
Sm0 Sm1
16Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Equilibrium in the Money Market
Equilibrium in the money market occurs at the intersection of the money demand and money supply curves
The equilibrium interest rate is inversely related to the money supply
17Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Equilibrium in the Money MarketFigure 13.5, Page 321
Surplus
Shortage
Dm
Sm
Money Demand andSupply Curves
0 10 20 30 40 50 60 70 80
1
2
3
4
5
Quantity of Money ($ billions)
Nom
inal In
tere
st R
ate
(%
)
Money Demand andSupply Schedules
NominalInterest
Rate(%)
($ billions)(surplus (+) or shortage (-))
QuantitySupplied
QuantityDemanded-
532
(50 – 40) = +10(50 – 50) = 0(50 – 60) = - 10
18Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Money Creation (a)
Desired reserves are the minimum cash reserves that deposit-takers hold to satisfy anticipated withdrawal demands
The reserve ratio equals desired reserves divided by deposits
Excess reserves equal cash reserves minus desired reserves
As long as excess reserves exist new money will be created
19Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Opening a DepositFigure 13.6, Page 323
Cabot Bank
Assets Liabilities
Saver A’s Deposit $1000Cash Reserves +$1000
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Granting a LoanFigure 13.7, Page 324
Cabot Bank
Assets Liabilities
Saver A’s Deposit $1000Borrower X’s Deposit +$900
Cash Reserves $1000Loan to Borrower X +$900
21Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Withdrawing a DepositFigure 13.8, Page 324
Cabot Bank
Assets Liabilities
Saver A’s Deposit $1000Borrower X’s Deposit$0($900 - $900)
Cash Reserves $100($1000 - $900)Loan to Borrower X $900
22Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Accepting Deposit FundsFigure 13.9, Page 325
Fraser Bank
Assets Liabilities
Saver B’s Deposit +$900Cash Reserves +$900
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Granting a LoanFigure 13.10, Page 325
Fraser Bank
Assets Liabilities
Saver B’s Deposit +$900Borrower Y’s Deposit +$810
Cash Reserves +$900Loan to Borrower Y +$810
24Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
Money Creation (b)
The money multiplier
• is the value by which an amount of excess reserves is multiplied to give the maximum change in the money supply
• equals (1/the reserve ratio) The actual money supply change is less than
the maximum amount found using the above formula because of publicly held currency and non-monetary deposits
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