Chapter 3. What is Money?Chapter 3. What is Money?Chapter 3. What is Money?Chapter 3. What is Money?

• meaning of money

• functions of money

• forms of money

• measuring money

• meaning of money

• functions of money

• forms of money

• measuring money

I. The Meaning of MoneyI. The Meaning of MoneyI. The Meaning of MoneyI. The Meaning of Money

• anything commonly excepted

in exchange for goods/services

• many objects throughout history

• anything commonly excepted

in exchange for goods/services

• many objects throughout history

examplesexamplesexamplesexamples

• livestock

•metals

•cigarettes

•grain

•shells

• livestock

•metals

•cigarettes

•grain

•shells

money, income, & wealthmoney, income, & wealthmoney, income, & wealthmoney, income, & wealth

• money what is accepted as payment

• income earnings during time period (year)

• wealth accumulated assets at pt. in time

• money what is accepted as payment

• income earnings during time period (year)

• wealth accumulated assets at pt. in time

• money, wealth are STOCKS amount at a point in time

• income is a FLOW amount during a time period

• money, wealth are STOCKS amount at a point in time

• income is a FLOW amount during a time period

examplesexamplesexamplesexamples

• I own $2 million in diamonds. period. I am wealthy I have no money

• I own $2 million in diamonds. period. I am wealthy I have no money

• I win $25 million in lottery

• I put it under my bed

• I quit my job I am weathly I have a lot of money my income is zero

• I win $25 million in lottery

• I put it under my bed

• I quit my job I am weathly I have a lot of money my income is zero

• software engineer

• earnings $100,000/yr

• blows it all, every paycheck high income no wealth

• software engineer

• earnings $100,000/yr

• blows it all, every paycheck high income no wealth

II. Functions of MoneyII. Functions of MoneyII. Functions of MoneyII. Functions of Money

• money is a medium of exchange

-- accepted as payment for

goods and services

-- main function of money

• money is a medium of exchange

-- accepted as payment for

goods and services

-- main function of money

without money,without money,without money,without money,

• barter for stuff

-- need “double coincidence

of wants”

-- inefficient:

more time shopping,

less time producing

• barter for stuff

-- need “double coincidence

of wants”

-- inefficient:

more time shopping,

less time producing

exampleexampleexampleexample

• I have exam 2,

want to trade it for soda• I have exam 2,

want to trade it for soda

You have to want the exam &

be willing to give up soda

AND

I have to want the soda

& be willing to give up exam

You have to want the exam &

be willing to give up soda

AND

I have to want the soda

& be willing to give up exam

double coincidence of wantsdouble coincidence of wantsdouble coincidence of wantsdouble coincidence of wants

to act as money, must beto act as money, must beto act as money, must beto act as money, must be

• measurable

• divisible

• widely accepted

• durable

• measurable

• divisible

• widely accepted

• durable

• money is a standard of value

-- or unit of account

-- money is used to

measure value

• money is a standard of value

-- or unit of account

-- money is used to

measure value

• if something costs $5,

not that valuable

• if something costs $500,

that’s valuable

• if something costs $5,

not that valuable

• if something costs $500,

that’s valuable

• money is a store of value

-- use money to save,

accumulate wealth,

buy stuff later

-- money is liquid asset

• money is a store of value

-- use money to save,

accumulate wealth,

buy stuff later

-- money is liquid asset

• money is NOT always

a good store of value

-- political instability

-- poor economy

-- high inflation

• money is NOT always

a good store of value

-- political instability

-- poor economy

-- high inflation

exampleexampleexampleexample

The dollar has been an excellent store of value

• 70% of U.S. currency is held outside the U.S

• but if $ continues to fall, this could change…

The dollar has been an excellent store of value

• 70% of U.S. currency is held outside the U.S

• but if $ continues to fall, this could change…

III. Forms of MoneyIII. Forms of MoneyIII. Forms of MoneyIII. Forms of Money

• commodity money

has its own value as a good

-- gold & silver coins

• commodity money

has its own value as a good

-- gold & silver coins

• fiat money

-- no value other than

fact that it’s accepted

in exchange for

goods and services

• fiat money

-- no value other than

fact that it’s accepted

in exchange for

goods and services

U.S. money is fiat U.S. money is fiat money!money!U.S. money is fiat U.S. money is fiat money!money!

• NOT backed by gold since 1934

• coins do not contain silver• NOT backed by gold since 1934

• coins do not contain silver

fiat money is more efficientfiat money is more efficientfiat money is more efficientfiat money is more efficient

• commodity money has

opportunity cost:

you could use it

for something else

• commodity money has

opportunity cost:

you could use it

for something else

debit or credit cards?debit or credit cards?debit or credit cards?debit or credit cards?

• NOT money

• payment mechanisms that access money

• NOT money

• payment mechanisms that access money

IV. Measuring MoneyIV. Measuring MoneyIV. Measuring MoneyIV. Measuring Money

• amount of cash

BUT

• other forms of money too

• amount of cash

BUT

• other forms of money too

M1M1M1M1

= currency in circulation

+ demand deposits

+ checkable deposits

+ traveler’s checks

= currency in circulation

+ demand deposits

+ checkable deposits

+ traveler’s checks

M2M2M2M2

= M1

+ savings deposits

+ small time deposits

+ money market deposits

+ other stuff

= M1

+ savings deposits

+ small time deposits

+ money market deposits

+ other stuff

M3M3M3M3

• M2

+ large time deposits

+ other stuff

• M2

+ large time deposits

+ other stuff

LLLL

= M3

+ other stuff

= M3

+ other stuff

Comparing measuresComparing measuresComparing measuresComparing measures

• get larger M1 < M2 < M3 < L

• add less liquid assets to larger measures

• get larger M1 < M2 < M3 < L

• add less liquid assets to larger measures

Components of M1

1%

23%

28%

48%

currency

traveler's checks

demand deposits

other checkable

Components of M2M1

22%

small CDs20%savings

39%

money market19%

Components of M3

M269%

large CDs10%

eurodollars3%

repos5%

money market13%

Which measure is best?Which measure is best?Which measure is best?Which measure is best?

• move together in general

• BUT behavior can vary in short-term

• M2 most watched

• move together in general

• BUT behavior can vary in short-term

• M2 most watched