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Understanding Money: Functions, Evolution, and Measures

Explore the various aspects of money, including its functions as a medium of exchange, unit of account, and store of value. Learn about the evolution of the payments system and measures of money stock. Gain insights into the growth rates of M1 and M2 aggregates over the years.

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Understanding Money: Functions, Evolution, and Measures

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  1. Meaning of Money • Money (money supply)—a generally accepted means of payment for goods, services or debts • Money is a stock …the stock of dollars in our wallets …the stock of credits in our bank accounts • Wealth—the total of assets that store value • Money is one component of our wealth • Income—the flow of earnings per unit time • We earn income .. we don’t “make money” (unless we’re counterfeiters)

  2. Functions of Money … the usual suspects • Medium of Exchange — promotes economic efficiency by minimizing the time spent buying things • Must be easily standardized … widely accepted … divisible … easy to carry … durable • Unit of Account — measures value • Prices set / records kept / contracts made in money terms • Store of Value —stores purchasing power • Most liquid of all assets • Yields no or minimal interest • Keeps its nominal value: $1 is a $1 • Loses value during inflation

  3. Evolution of the Payments System • Commodity Money • Fiat Money • Checks • Electronic Payment • E-Money Measures of Money Stock • Revisions are issued because: • Small depository institutions report infrequently • Be concerned only with longer-run movements of money supply measures

  4. Growth Rates of the M1 and M2 Aggregates, 1960–2008 Sources: Federal Reserve Bulletin, p. A4, Table 1.10, various issues; Citibase databank; www.federalreserve.gov/releases/h6/hist/h6hist1.txt.

  5. Growth Rate of M2: Initial and Revised Series, 2008 (percent, compounded annual rate)

  6. 2.2 If I can buy a car today for $5,000 and it is worth $10,000 in extra income next year to me because it enables me to get a job as a traveling anvil seller, should I take a loan from Larry the Loan Shark at a 90% interest rate if no one else will give me a loan? 2.7 How can the adverse selection problem explain why you are more likely to make a loan to family member than to a stranger? • 3.8 Rank the following assets from most liquid to least liquid: • Checking account deposits; b) Houses; c) Currency; • d) Washing machines; e) Savings deposits; f) Commons stock. 3.10 In Brazil, a country that underwent a rapid inflation before 1994, many transactions were conducted in dollars rather than reals. Why? 3.14 For each of the following, indicate the monetary aggregate (M1, M2) that includes them: Currency; b) Money market mutual funds; c) Small-denomination CDs; d) Checkable deposits.

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