15. Nature and Functions of Money

1. 15. Nature and Functions of Money

2. Chapter 15 : main menu

3. Concept Explorer 15.1 • Credit cards and the functions of money • What functions of money do credit cards perform? Are credit cards money?

4. Concept Explorer 15.1

5. Concept Explorer 15.1 • As credit cards cannot settle transactions and debts, they are not money. Yet, credit cards can act as a means of deferred payment, because cardholders can defer payment by asking banks to pay for them temporarily. • Reminder : • Money is only a standard of deferred payment, but NOT a means of deferred payment.

6. Theory in Life 15.1 • Identifying whether there is money • Is there money in each of the following case?

7. Progress Checkpoint 1 Q15.1 Peter : “I want to trade my potato with your tomato now.” Tom : “But I wanted to exchange my tomato with potato two weeks ago. What I want now is some fish.” Explain what problem of exchange exists in this case and how money solves the problem.

8. Progress Checkpoint 1 • The problem is a lack of double coincidence of wants. This is because Tom does not want to exchange the potato Peter has at the same time. With money, Tom can sell tomato to Peter first, and use the money to buy fish from someone later. The acts of purchase and sale are separated.

9. Progress Checkpoint 1 Q15.2 Which function of money will be affected most in times of inflation? Store of value, because the purchasing power of money will fall in inflation.

10. Progress Checkpoint 1 Q15.3 Why is gold a better form of money than pearl? Give THREE reasons. It is because gold is more generally acceptable, scarce, easily divisible and homogeneous.

11. Theory in Life 15.2 • The Easy Pay System and the Payment-by-Phone System • Can savings deposits perform the medium of exchange function? • The Easy Pay System (EPS) (易辦事) and the Payment-by-Phone System (PPS) (繳費靈) enable savings deposits to be used as a medium of exchange. Through the integrated terminals, phone system or internet, customers may pay by directly transferring their demand or savings deposits to the seller’s bank account immediately.

12. Theory in Life 15.3 • The choice of investment opportunity • After retirement, Rick receives $1 million from pension scheme. He is considering whether to deposit this amount in savings account, time deposits account or to buy shares. What will be the suitable choice if he wants to (a) have high liquidity, (b) have certain return, (c) have the maximum possible return, and (d) avoid risk?

13. Theory in Life 15.3 • Liquidity (流動性) refers to the ease of converting an asset (資產) into cash at low cost. If he wants to have high liquidity, he should deposit his money in a savings account. This is because he may withdraw the money at any time. • If he wants to have certain return, he should deposit his money in a time deposits account. This is because the interest rate is fixed. He knows how much interest to obtain.

14. Theory in Life 15.3 • If he wants to have the maximum possible return, he should buy shares. This is because if share prices rise sharply, his return will be very high. • If he wants to avoid risk, he should deposit his money in a time deposits account. This is because the interest rate is fixed. For savings deposits, the interest rate can be adjusted by banks from time to time.

15. Progress Checkpoint 2 Q15.4 Banknotes and coins in Hong Kong have no intrinsic value. Why do we use them as money? It is because the government declares them as legal tender, and we generally accept them as medium of exchange.

16. Progress Checkpoint 2 Q15.5. Do Octopus cards perform the functions of money as a unit of account and a standard of deferred payment? No. Prices of commodities and future payment are not expressed in terms of number of Octopus cards.

17. Progress Checkpoint 2 Q15.6 Is there money in a Robinson Crusoe (i.e. one-man) economy? • No, because there is no market exchange

18. Concept Explorer 15.2 • Cash Vs Money • Is there anything money but not cash? Is there anything cash but not money? Is there anything both money and cash?

19. Concept Explorer 15.2 • When cash is possessed by the public, it is money. This is because the cash held will be used as a medium of exchange in market transaction. • However, when the public deposit cash, the cash will be kept by banks as reserves (儲備). Banks do not use these reserves for their own expenses. They will either pay the reserves to the public who withdraw deposits, or lend them to other borrowers. Since both are not market transactions of final output, the reserves are not used as a medium of exchange. Therefore, cash reserves kept inside banks are not money.

20. Cash Money (M1) Cash held by banks = reserves Cash held by public Dd in banks Concept Explorer 15.2

21. Concept Explorer 15.3 • M1, M2 & M3 • Given the following information: • If M2 = $2 000 million, what are the values of • demand deposits, • (b) M1 and (c) total amount of bank deposits?

22. Concept Explorer 15.3 • M2 = Cp + Dd + Ds + Dtb M1 = Cp + Dd • $2 000 m = $(200 + Dd + 500 + 1 000) m M1 = $(200 + 300) m • Dd = $300 m M1 = $ 500 m • Total amount of bank deposits = Dd + Ds + Dtbanks = $(300 + 500 + 1 000) = $1 800 m

23. Concept Explorer 15.4 • M1, M2 & M3 • Given the following table. What are the values of (a) currency in public circulation, (b) M1, (c) M2 and (d) M3 respectively?

24. Concept Explorer 15.4 (a) Currency in public circulation (Cp) = Total issue of legal tender – Legal tender held by authorized institutions = $(100 000 – 20 000) m = $80 000 m

25. Concept Explorer 15.4 (b) M1 = Cp + Dd = $(80 000 + 150 000)m = $230 000 m (c) M2 = M1 + Ds + Dtbanks + Cdbanks = $(230 000 + 130 000 + 400 000 + 350 000)m = $1 110 000 m (d) M3 = M2 + DRLB + DDTC + CDRLB + CDDTC = $(1 110 000 + 200 000 + 150 000)m = $1 460 000m

26. Theory in Life 15.4 • The Payment-by-Phone System • Kyle settles his mobile phone bill by the Payment-by-Phone System (PPS). When he uses the service, the amount of payment is deducted from his savings account, and the savings account of the mobile phone service company in bank will be credited by the same amount. How is money supply M2 affected?

27. Theory in Life 15.4 • When deposit is deducted from Kyle’s bank account, M2 decreases. When it is transferred to the company’s bank account, M2 increases by the same amount. Therefore M2 is not affected.

28. Concept Explorer 15.5 The change in M1, M2 & M3 How will M1, M2 and M3 be affected in each of the following cases? • (a) Mr. A transfers $100 from current account in savings account. • (b) Mr. B returns the certificate of deposits to a deposit- taking company, and deposits the $1 million received into a current account.

29. Concept Explorer 15.5 (a) When Mr. A withdraws $100 from current account, demand deposits falls by $100. Thus M1, M2 and M3 fall by $100. When he deposits the $100 in savings account, savings deposits rises by $100. Thus M2 and M3 rise by $100. Finally, M2 and M3 do not change. (b) When Mr. B withdraws $1 million from a DTC, CD issued by a DTC but held by the public falls by $1 million. Thus M3 falls by $1 million. When he deposits this amount in a current account, demand deposits rises by $1 million. Both M1 and M2 rise by $ 1 million. As M3 includes demand deposits, M3 rises by $1 million. Finally, M3 does not change.

30. Progress Checkpoint 3 Q15.7 Suppose Sonia withdraws deposits from a time deposits account in a licensed bank, and buys a certificate of deposits issued by a deposit-taking company, how will M1, M2 and M3 be affected? When she withdraws deposits from the licensed bank, M2 will fall. When she buys a CD issued by a DTC, M3 does not change. This is because M3 includes both time deposits in licensed bank and CD issued by DTC. M1 also does not change.

31. Progress Checkpoint 3 Q15.8 Arrange the following items in terms of liquidity (i.e. the ease of converting it into cash) in ascending order : (a) certificate of deposits issued by a licensed bank (c) real properties (b) currency (d) savings deposits Real properties, CDs,, savings deposits, currency.

32. End of Chapter 15