Lecture 3 - What is money? A comparative approach to measuring money

Question 1

What is money?

Answer 1

Anything that is generally accepted in payment for goods and services or in the repayment of debts.

Question 2

What is wealth?

Answer 2

The total collection of pieces of property that serve to store value.

Question 3

What is the difference between income and money?

Answer 3

Income is a flow of earnings per unit of time whereas, money is a stock; it is a certain amount at any given time.

Question 4

What are the three functions of money?

Answer 4

Medium of exchange, unit of account, and store of value.

Question 5

What does medium of exchange mean?

Answer 5

It is used to pay for goods and services. It promotes economic efficiency by minimising the time spent in exchanging goods and services (transaction costs). In the barter economy, transaction costs are high because people have to satisfy a ‘double coincidence of wants’. If money is introduced, it allows people to specialise in what they do best and encourages the division of labour.

Question 6

For a commodity to function effectively as money, it has certain criteria to meet. What are these?

Answer 6

Be standardised (easy to determine its value), be widely accepted, be divisible (it is easy to ‘make change’), be easy to carry and not deteriorate quickly.

Question 7

What is the second role of money?

Answer 7

To provide a unit of account that is used to measure the value in an economy. Using money as a unit of account reduces transaction costs in an economy by reducing the number of prices that need to be considered.

Question 8

Money also functions as a store of value. What does this mean?

Answer 8

It is a repository of purchasing power over time. A store of value is used to save purchasing power from the time income is received until the time it is spent. This function is useful, because most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until we have the time or the desire to shop.

Question 9

Money is not unique as a store of value but why do other assets have advantages over money as a stere of value?

Answer 9

Other assets often pay the owner a higher interest rate than money, experience price appreciation and deliver services (e.g. house).

Question 10

Money is the most liquid asset, it is the medium of exchange. How does this differ to other assets?

Answer 10

Other assets have to be converted into money to make purchases and transaction costs would arise.

Question 11

What is liquidity?

Answer 11

It is the relative ease and speed with which an asset can be converted into a medium of exchange.

Question 12

How good a store of value money is, depends on the…

Answer 12

Price level.

Question 13

A doubling of all prices means that…

Answer 13

The value of money has dropped by half.

Question 14

A halving of all prices means that…

Answer 14

The value of money has doubled.

Question 15

What is the payments system?

Answer 15

The method of conducting transactions in the economy.

Question 16

What is commodity money?

Answer 16

Money made up of precious metals or another valuable commodity. From ancient times until several hundred years ago, commodity money functioned as the medium of exchange in all but the most primitive societies.

Question 17

Examples of commodity money.

Answer 17

Gold, silver, shells, cattle, peppercorns, tobacco. These goods with an ‘intrinsic value’ - a direct use. Their value was directly observable as they could be used for something valuable.

Question 18

What was the problem with commodity money?

Answer 18

The form of money is very heavy and hard to transport from one place to another (gold and silver). Peppercorns were perishable, cattle were not easily divisible and shells could easily break.

Question 19

What is fiat money?

Answer 19

Paper currency decreed by governments as legal tender (meaning that legally it must be accepted as payment for debts) but not convertible into coins or precious metal.

Question 20

Advantages of paper currency.

Answer 20

Paper currency has the advantage of being much lighter than coins or precious metal, but it can be accepted as a medium of exchange only if there is some trust in the authorities who issue it and if printing has reached a sufficiently advanced stage that counterfeiting is extremely difficult. Countries can change the currency that they use at will as paper currency has evolved into a legal arrangement.

Question 21

Disadvantages of paper currency.

Answer 21

They are easily stolen and can be expensive to transport in large amounts because of their bulk.

Question 22

What are cheques?

Answer 22

Instructions from the customer to the bank to transfer money from their account to someone else’s account when they deposit a cheque. They allow transactions to take place without the need to carry around large amounts of currency.

Question 23

Advantages of cheques.

Answer 23

Improves economic efficiency and reduces transaction costs. They can be written for any amount up to the balance in the account, making transactions for large amounts much easier. Loss from theft is also greatly reduced, and because they provide convenient receipts for purchases.

Question 24

Disadvantages of cheques.

Answer 24

It takes time to get cheques from one place to another, a particularly serious problem if you are paying someone in a different location who needs to be paid quickly. Also, it usually take several business days before a bank will allow you to make sue of the funds from a cheque you have deposited. If your need for cash is urgent, this feature of paying by cheque can be frustrating. Furthermore, all the paper shuffling required to process cheques is costly.

Question 25

How do electronic payments benefit us?

Answer 25

It has now become cheap and really quick to transfer funds and pay bills electronically.

Question 26

What is electronic money?

Answer 26

Money that exists only in electronic form. Examples include debit cards and smart cards. Smart cards are stored value cards that contain a computer chip that allows it to be loaded with digital cash from the owner’s bank account whenever needed. They can be loaded with digital cash from ATMs. A third form of electronic money is e-cash.

Question 27

What are Bitcoins?

Answer 27

A digital currency not issued by a Central Bank that can be exchanged directly among users, with transactions being verified and recorded on a public register.

Question 28

How good is Bitcoin as a use of money?

Answer 28

They are accepted as a medium of exchange although not universally. They are not subject to inflation, as their quantity is limited and known in advance. Their decentralised and anonymous nature can be exploited for illegal purposes.

Question 29

What are monetary aggregates?

Answer 29

Variations among measure of money supply. Generally ranges from narrow to broad definitions. They do not usually move together.

Question 30

What affects the measurement of monetary aggregates?

Answer 30

Differences in what members of society accept as a means of exchange (e.g. Mexico with pesos and US dollars). Moreover, some assets are accepted as money in some societies by not others (e.g. in those countries where banks are not sufficiently widespread to attract household savings, most of the money supply would be in cash). The institutions responsible for issuing monetary aggregates differ from country to country (in US the Federal Reserve Bank issues money and in the Euro area the European Central Bank issues money and in the UK the Bank of England issues money) . Definition of monetary aggregate changes over time as people’s habits change.

Question 31

What is M1?

Answer 31

Consists of currency in circulation as well as demand deposits and other chequeable deposits held in depository institutions. Definition tends to be pretty similar across central banks.

Question 32

What is M2?

Answer 32

Includes saving deposits and time deposits. Extremely liquid assets. Definitions vary more considerably across central banks.

Question 33

What is M3?

Answer 33

Includes repurchase agreements. Only some central banks calculate it. The definition varies widely across countries.

Question 34

How do central banks resort to boosting GDP growth?

Answer 34

Expanding the money supply, albeit with the understanding that this is apt to result in inflation.