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Understanding Money: Definitions, Characteristics, and Key Measures in Macroeconomics

Money is defined as anything that can be used as a medium of exchange, a store of value, and a unit of account. For money to be effective, it should be portable, durable, divisible, acceptable, and stable. The U.S. dollar, recognized as legal tender, is backed by faith in the government, rather than gold. The Federal Reserve controls the money supply, measured with M1 (currency and checkable deposits) and M2 (which includes M1 plus savings accounts and more). Liquidity is crucial—M1 is more liquid than M2, and a dollar today is worth more than a dollar tomorrow due to opportunity cost and inflation.

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Understanding Money: Definitions, Characteristics, and Key Measures in Macroeconomics

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  1. AP Macroeconomics Money: Definitions, Characteristics, and Measures of

  2. Money Defined • Money is anything that can be used as: • A medium of exchange (a way to get what you want) • A store of value (a way to preserve wealth) • A unit of account / Standard of Value (compare prices)

  3. Characteristics of Money • Money works best when it meets these criteria: • Portable • Durable • Divisible • Acceptable • Stable

  4. Money Facts: • What backs the dollar and makes it valuable? • Gold? • NO! The dollar is legal tender because the government says it’s money and people willingly accept it. The Dollar is backed by FAITH. • This is referred to as an inconvertible fiat standard.

  5. The Supply of Money • In the United States, the Federal Reserve System is the sole issuer of currency. • This means the Fed has monopoly control over the money supply. • There are two important measures of the Money Supply today. • M1(narrowest definition) • M2 (includes M1)

  6. M1 • M1 serves primarily as a medium of exchange. It includes: • Currency and Coin • Checking accounts • Both are very liquid

  7. M2 • M2 serves as a store of value. It includes: • The M1+ • Saving Accounts+ • Time Deposits+ • Money Market+ Mutual Funds Certificates of Deposit Savings Accounts

  8. M1 & M2 • As we go from M1 to M2 • The measure becomeslarger • Money becomes less liquid • As we go from M2 to M1 • Themeasurebecomes smaller • Money becomesmoreliquid

  9. Summary • M1=currency + checkable deposits • M2=savings accounts, time deposits, money market mutual funds PLUS M1. • Which will always be greater, M1 or M2? • That’s right, M2 • What does liquidity mean? • How quick an asset can be converted into cash • Which is more liquid, M1 or M2? • That’s right, M1. M1 includes CASH and checkable deposits.

  10. Time Value of Money • Is a dollar today worth more than a dollar tomorrow? • YES • Why? • Opportunity cost & Inflation • This is the reason for charging and paying interest ???

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