UNIT 4 MONEY

Uses of Money: 

• Medium of exchange: trade or barter
• Unit of account: establishes economic worth in the exchange process -Store of value: money has its value over a period of time, where products may not  

Types of Money: 

• Commodity money: gets it value from the type of material from which it is made
•     ex: gold and silver coins 
• Representative money: paper money backed up by something tangible that it gives it value  
• Fiat Money: money because government says it is money and that is used in the U,S  

Characteristics of money: 

• portable 
• durable
• uniform
• scarce
• acceptable 
• divisible  

Money Supply:

• M1 money: currency (cash, coins, checkable deposits/ checking account, traveler's checks, and demand deposits) 
• 75% of money in circulation and it mostly liquid because it easy ti convert to cash  
• M2 money: consists of M1 money  + savings accounts and deposits held by banks held outside of the U.S

Time value of money:

Is a dollar today worth more than a dollar tomorrow?

 YES

Why?

• Opportunity cost and inflation
• Let v= future value of money
• Let p= present value of  money
• Let r= real interest rate (nominal rate- inflation rate) expressed as a decimal  
• Let n = years
• Let k= # of times interest is credited per year
• Simple interest forumla: v=  (1+r)^n * p 
• Compound interest forumla: v= (1+r/k)^nk *p 
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded  

What happened to the quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest rate assets instead of borrowed liabilities

What happens to the quantity demanded when interest rates decrease? 

• Quantity demanded increase, there is no incentive to convert cash into interest earning assets      
• Demand for money 

Money demand shifters:

• Change in price level
• Change in income 
• Change in taxation of investments

How money supply affects AD? 

• Money supply increases= decrease in interest rates, increase in investments, and decrease in AD
• Money supply decreases = increase in interest rate, decrease in investment, decrease in AD
• Financial Assets vs Financial Liabilities 
• FA: assets such as stocks and bonds provide expected future benefits 
• It benefits the owner, based upon the issue of the asset meeting certain obligations
• FL: liabilities incurred by financial asset to stand behind the issued asset  
• Interest rate: price paid for a financial asset 

Stocks vs Bonds: 

• Stocks: assets that convey ownership in a company
• Bonds: promise to pay a certain amount of money + interest in the future

What banks do?

• It is a financial intermediary  
• Uses liquid assets (i.e. bank deposits) to finance the investments of borrowers
• Process known as Fractional Reserve Banking
• A system in which depository institutions hold liquid assets > the amount of deposits  
• Can take form of currency in bank vaults