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Money, Measurement, and Time Cost

Money, Measurement, and Time Cost. What is Money?. Any asset that can easily be used to purchase goods and services Two monetary aggregates define this differently: M1 = Currency in circulation + checkable bank deposits + traveler’s checks

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Money, Measurement, and Time Cost

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  1. Money, Measurement, and Time Cost

  2. What is Money? • Any asset that can easily be used to purchase goods and services • Two monetary aggregates define this differently: • M1 = Currency in circulation + checkable bank deposits + traveler’s checks • M2 = M1 + savings deposits + time deposits + money market funds

  3. Roles of Money • Existence of money improves standard of living, as it eliminates “double coincidence of needs” • Medium of Exchange – asset used to trade for goods and services • Store of value – Non-perishable, holds purchasing power of time • Unit of account – Commonly accepted measure used to set prices & make calculations

  4. Types of Money • Commodity money – A good with intrinsic value • Commodity-backed money – MOE without intrinsic value but guaranteed by conversion on demand • Fiat money – MOE with value derived from its official status as such • Advantages – Takes up no real resources; amount in circulation is decided by needs of the economy • Disadvantages – Can be counterfeited; printing too much can lead to inflation

  5. Time Value of Money In general, having a dollar today is worth more than a dollar a year from now Time value is a consideration when evaluating projects, so economists use present value to make comparison easier – using interest rate to compare the value of a dollar received today with value of a dollar received later

  6. Present Value Equation Amount received one year from now as a result of lending: $X + ($X  r) OR $X  (1 + r) Amount lent today to receive $1 a year from now: $X = $1/(1 + r) For lending beyond one year: $X  (1 + r)N AND $X = 1/(1 + r)N with N = # of years lent

  7. Evaluating Using Present Value

  8. Monetary Equation of Exchange Depicts the relationship between money supply, income velocity, price level, and real output MV = PQ Changes in money supply result in changes in nominal GDP (P  Q) Like the Savings-Investment Spending Identity, this is always true

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