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Principles of Money: Barter Exchange, Characteristics, and Money Supply

This chapter explores the principles of money, including barter exchange, the characteristics of money, gold-backed and fiat money, liquidity, the equation of exchange, and the theories of money. It also discusses the impressive growth of M2 money and the dividing line between money and nonmoney assets.

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Principles of Money: Barter Exchange, Characteristics, and Money Supply

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  1. Chapter 25 Money Gottheil — Principles of Economics, 7e

  2. Economic Principles • Barter exchange • The characteristics of money • Gold-backed and fiat money • Liquidity Gottheil — Principles of Economics, 7e

  3. Economic Principles • The equation of exchange • The quantity theory of money • The classical view of money • The Keynesian view of money • Monetarism Gottheil — Principles of Economics, 7e

  4. Introduction Barter • The exchange of one good for another, without the use of money. Gottheil — Principles of Economics, 7e

  5. Introduction 1. What is the key problem with barter exchange? • To function effectively, barter requires a double coincidence of each party to the exchange wanting precisely what the other has to offer. A double coincidence of wants is difficult to achieve. Gottheil — Principles of Economics, 7e

  6. The Invention of Money Money • Any commonly accepted good that acts as a medium of exchange, a measure of value, and a store of value. Gottheil — Principles of Economics, 7e

  7. The Invention of Money Money must be durable, portable, divisible, homogeneous, and supplies must be stable. Gottheil — Principles of Economics, 7e

  8. The Invention of Money Which of the following is most likely to serve as money: a. Strawberries b. Cows c. Gold d. Water Gottheil — Principles of Economics, 7e

  9. The Invention of Money Which of the following is most likely to serve as money: a. Strawberries b. Cows c. Gold d. Water Gottheil — Principles of Economics, 7e

  10. The Invention of Money Which of the following is most likely to serve as money: • Strawberries are not durable, cows are not easily divisible, and most of the time the supply of water is too abundant and difficult to control. Gottheil — Principles of Economics, 7e

  11. The Invention of Money Gold makes a good type of money because: a. Gold supplies are fairly stable. b. Gold is homogeneous. c. Gold is durable. d. Gold is divisible. e. Gold is portable. Gottheil — Principles of Economics, 7e

  12. The Invention of Money Fiat money • Paper money that is not backed by or convertible into any good. Gottheil — Principles of Economics, 7e

  13. Fluffy Rabbits and Gresham’s Law Suppose more valuable silver quarters and less valuable copper-nickel quarters freely circulate together in the economy. What would happen over time? • People would keep the more valuable silver quarters, and eventually only the less valuable copper-nickel quarters would freely circulate. Gottheil — Principles of Economics, 7e

  14. Fluffy Rabbits and Gresham’s Law Suppose more valuable silver quarters and less valuable copper-nickel quarters freely circulate together in the economy. What would happen over time? • Sir Thomas Gresham, a 16th century merchant to the English crown, observed that bad money drives out good. Gottheil — Principles of Economics, 7e

  15. Money in a Modern Economy Currency • Coins and paper money. Gottheil — Principles of Economics, 7e

  16. Money in a Modern Economy Liquidity • The degree to which an asset can easily be exchanged for money. Gottheil — Principles of Economics, 7e

  17. Money in a Modern Economy Liquidity is what distinguishes money from any other asset form. • Some assets are relatively liquid, and can serve as money. • Most assets are highly illiquid and thus far removed from serving as money. Gottheil — Principles of Economics, 7e

  18. Money in a Modern Economy Money supply • Typically, M1 money. The supply of currency, demand deposits, and traveler’s checks used in transactions. Gottheil — Principles of Economics, 7e

  19. Money in a Modern Economy M1 Money supply • The supply of the most immediate form of money. It includes currency, demand deposits, and traveler’s checks. Gottheil — Principles of Economics, 7e

  20. Money in a Modern Economy M2 Money supply • M1 money plus less-immediate forms of money, such as savings accounts, money market mutual fund accounts, money market deposit accounts, repurchase agreements, and small-denomination time deposits. Gottheil — Principles of Economics, 7e

  21. Money in a Modern Economy M3 Money supply • M2 money plus large-denomination time deposits and large-denomination repurchase agreements. Gottheil — Principles of Economics, 7e

  22. Explaining the Impressive Growth of M2 Money What caused the impressive growth of M2 money? • Deregulation of the banking industry led to a large increase in money market accounts (mutual funds and deposit accounts), and increased the liquidity of savings accounts. Gottheil — Principles of Economics, 7e

  23. Money in a Modern Economy The dividing line between money and nonmoney assets is blurry. Most any asset is potential money. Gottheil — Principles of Economics, 7e

  24. Money in a Modern Economy Why would a government lose money “making” money—coins like the penny and nickel? • Metal prices have tripled since 2003. • Because copper, zinc, and nickel are commodities, we have no control over their prices. Gottheil — Principles of Economics, 7e

  25. Money in a Modern Economy Are credit cards a form of money? • No. They may be accepted as readily as money by stores, but credit cards are loans that must be repaid. Gottheil — Principles of Economics, 7e

  26. EXHIBIT 1 U.S. MONEY SUPPLY: 2008 ($ BILLIONS) Source:Federal Reserve Bulletin (Washington, D.C.: Federal Reserve, September 2008), p. A13, table 1.21. Gottheil — Principles of Economics, 7e

  27. Exhibit 1: U.S. Money Supply: 2008 1. True or false: The largest component of M1 is demand deposits. • False. In 2008 currency was over $760 billion of the $1,374.8 billion supply of M1 money. Gottheil — Principles of Economics, 7e

  28. Exhibit 1: U.S. Money Supply: 2006 2. True or false: The largest component of M2 is M1. • False. In 2006 M1 was $1,376.9 billion, but savings deposits and money market accounts made up $3,657.4 of the $6,761.2 billion supply of M2 money. Gottheil — Principles of Economics, 7e

  29. EXHIBIT 2 GROWTH OF THE MONEY SUPPLY:1970–2008 Gottheil — Principles of Economics, 7e

  30. Exhibit 2: Growth of the Money Supply: 1970–2008 M1 money increased from $214 billion in 1970 to $1,374.8 billion in 2008, or by an annual rate of 5.4 percent. The M2 money components (M2, M1) increased by 9.4 percent. Gottheil — Principles of Economics, 7e

  31. Exhibit 2: Growth of the Money Supply: 1970–2008 1. True or false: M1 grew more slowly than M2 between 1970 and 2008. • True. Deregulation of the banking industry increased elements of M2. Gottheil — Principles of Economics, 7e

  32. Exhibit 2: Growth of the Money Supply: 1970–2008 1. True or false: By 1992, M2 became larger than M3. • False. That cannot occur because M3 includes M2 plus other types of money. Gottheil — Principles of Economics, 7e

  33. Know Your Currencies? 1. Which of the following counties does not use the dollar as its currency? a. Hong Kong b. Ireland c. Zimbabwe d. Australia Gottheil — Principles of Economics, 7e

  34. Know Your Currencies? 1. Which of the following counties does not use the dollar as its currency? a. Hong Kong b. Ireland c. Zimbabwe d. Australia Gottheil — Principles of Economics, 7e

  35. Know Your Currencies? 2. Each of the European Union countries—with the exception of the United Kingdom—switched in 1999 from their national currencies to a common one. The name of this common currency is the a. EU b. Dollar c. Euro d. Common Gottheil — Principles of Economics, 7e

  36. Know Your Currencies? 2. Each of the European Union countries—with the exception of the United Kingdom—switched in 1999 from their national currencies to a common one. The name of this common currency is the a. EU b. Dollar c. Euro d. Common Gottheil — Principles of Economics, 7e

  37. Know Your Currencies? 3. The British currency is the a. Euro b. Pound c. Gold d. Sterling silver Gottheil — Principles of Economics, 7e

  38. Know Your Currencies? 3. The British currency is the a. Euro b. Pound c. Gold d. Sterling silver Gottheil — Principles of Economics, 7e

  39. Know Your Currencies? 4. What picture is on the face of the British currency? a. Buckingham Palace b. Queen Elizabeth II c. Princess Diana d. Union Jack Gottheil — Principles of Economics, 7e

  40. Know Your Currencies? 4. What picture is on the face of the British currency? a. Buckingham Palace b. Queen Elizabeth II c. Princess Diana d. Union Jack Gottheil — Principles of Economics, 7e

  41. Know Your Currencies? 5. In 1977, the Israelis switched their currency from the pound to the currency that was used in biblical Israel. That currency is the a. Lira b. Shekel c. Dinar d. Kroner Gottheil — Principles of Economics, 7e

  42. Know Your Currencies? 5. In 1977, the Israelis switched their currency from the pound to the currency that was used in biblical Israel. That currency is the a. Lira b. Shekel c. Dinar d. Kroner Gottheil — Principles of Economics, 7e

  43. Know Your Currencies? 6. Russia was once part of the U.S.S.R.—the Union of Soviet Socialist Republics—and the currency of the U.S.S.R. then was the ruble. Today, Russia’s currency is the a. Putin b. Pound c. Franc d. Ruble Gottheil — Principles of Economics, 7e

  44. Know Your Currencies? 6. Russia was once part of the U.S.S.R.—the Union of Soviet Socialist Republics—and the currency of the U.S.S.R. then was the ruble. Today, Russia’s currency is the a. Putin b. Pound c. Franc d. Ruble Gottheil — Principles of Economics, 7e

  45. Know Your Currencies? 7. Which country’s currency is not the peso? a. Brazil b. Mexico c. Argentina d. Philippines Gottheil — Principles of Economics, 7e

  46. Know Your Currencies? 7. Which country’s currency is not the peso? a. Brazil b. Mexico c. Argentina d. Philippines Gottheil — Principles of Economics, 7e

  47. Know Your Currencies? 8. China and Japan’s currencies are, respectively, the a. Yak and yang b. Yuan and yen c. Han and edo d. Yin and yan Gottheil — Principles of Economics, 7e

  48. Know Your Currencies? 8. China and Japan’s currencies are, respectively, the a. Yak and yang b. Yuan and yen c. Han and edo d. Yin and yan Gottheil — Principles of Economics, 7e

  49. Know Your Currencies? 9. India’s currency is the a. Ruble b. Riyal c. Rand d. Rupee Gottheil — Principles of Economics, 7e

  50. Know Your Currencies? 9. India’s currency is the a. Ruble b. Riyal c. Rand d. Rupee Gottheil — Principles of Economics, 7e

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