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Lecture What Is Money?. Chapters 3. Meaning of Money. Money - anything that is generally accepted in payment for goods or services or in the repayment of debts. A stock concept. It is an asset that can be used to make transactions.

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lecture what is money

What Is Money?

Chapters 3

meaning of money
Meaning of Money
  • Money - anything that is generally accepted in payment for goods or services or in the repayment of debts.
  • A stock concept. It is an asset that can be used to make transactions.
  • Money is different from wealth - the total collection of pieces of property that serve to store value. Money is a component of wealth
  • Money is different from income - flow of earnings per unit of time (a flow concept)
medium of exchange
Medium of Exchange
  • The alternative is barter.
    • For economic exchanges to occur using barter, ____________________ must exist.
coincidence of wants






to eat

needs to


wants to

read a




Coincidence of Wants







3 functions of money
3 Functions of Money

1) Medium of Exchange:

  • Eliminates the trouble of finding a double coincidence of needs (reduces transaction costs)
  • Promotes specialization
  • A medium of exchange must
    • be easily standardized
    • be widely accepted
    • be divisible
    • be easy to carry
    • not deteriorate quickly
functions of money
Functions of Money

(2) Unit of Account:

  • used to measure value in the economy

(3) Store of Value:

  • used to transfer purchasing power over time.
    • other assets also serve this function
  • Money is the most liquid of all assets but loses value during inflation
inseparability of the store of value and medium of exchange functions hyperinflation example
Inseparability of the Store-of-Value and Medium-of-Exchange Functions – Hyperinflation Example
  • During hyperinflation, individuals and firms frantically attempt to get rid of money because its value deteriorates rapidly - money fails as a store-of-value.
  • Merchants refuse to accept payment in money, insisting instead on payment in goods and services - money fails as a medium-of-exchange.
    • For money to function as a means of payment it must durable and capable of transferring purchasing power from one day to the next.
  • Measure of the ease an asset can be turned into a means of payment (money)
  • An asset is liquid if it can be easily converted into money and illiquid if it is costly to convert.
    • Cash is perfectly liquid.
    • Stocks and bonds are somewhat less liquid.
    • Land is illiquid.
measuring money
Measuring Money
  • How do we measure money? Which particular assets can be called “money”?
  • Monetary aggregates (M1 and M2) are constructed using the concept of liquidity:

M1 (most liquid assets)

M1 = currency + traveler’s checks + demand deposits

+ other checkable deposits.

measuring money1
Measuring Money
  • M2 adds to M1 other assets that are not so liquid
  • M2 = M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares.
m1 vs m2
M1 vs. M2
  • Which measure to use?
  • M1 and M2 can move in different directions in the short run (see figure).
what happened in the 80 s
What happened in the 80’s
  • High and rapid inflation in the 1980’s? Nominal interest rates increased
  • Checking accounts pay zero interest. New financial products introduced

– major innovation was the introduction of the money market mutual funds.

  • Funds shift from checking accounts (the M1 component of M2) to money market accounts (non-M1 component of M2).
  • The new money market accounts made M2 more liquid, so M2 looked at by analysts.