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ECON 4100Monetary Economics
William D. Lastrapes
Fall 2008
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Money
Specialization is necessary for high productivity, high
standards of living.
Trade and exchange are necessary for specialization.
Money reduces costs of and facilitates exchange.
So without money, low standard of living for all.
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Money
The study of money is the study of how people
trade, the mechanics of the payments system.
Such mechanics are typically ignored in micromodels of voluntary exchange and efficient
allocation of resources.
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Voluntary exchange without money
Barter: exchange of goods for direct consumption.
(Double) coincidence of wants: for mutuallybeneficial trade to occur under barter, a seller
must find a buyer who wants what he or she has,
and has what he or she wants.
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Voluntary exchange without money
The butcher has more meat in his shop than he
himself can consume, and the brewer and the
baker would each of them be willing to purchasea part of it. But they have nothing to offer in
exchange, except the different productions of
their respective trades, and the butcher is already
provided with all the bread and beer which he hasimmediate occasion for. No exchange can, in this
case be made between them. -- Adam Smith
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Solutions to the coincidence of wants
Central market (with trading posts). The key here
is providing information.
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Solutions to the coincidence of wants
Indirect barter: accept some goods for trade, not
consumption.
A stylized example:
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Solutions to the coincidence of wants
Preference Endowment First trade Final trade
Butcher Beer Meat Bread (from
baker)
Beer (from brewer)
Brewer Bread Beer Bread (from
butcher)
Baker Meat Bread Meat (from
butcher)
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Solutions to the coincidence of wants
Money will evolve from indirect barter as a single goodbecomes most saleable.
In order to avoid the inconveniency of such situations [no
possible exchange], every prudent man in every periodof society, after the first establishment of the division oflabour, must naturally have endeavoured to manage hisaffairs in such a manner as to have at all times by him,
besides the peculiar produce of his own industry, acertain quantity of some one commodity or other, suchas he imagined few people would be likely to refuse inexchange for the produce of their industry. -- Smith
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Claim on labor
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To Kill a Mockingbird
Good morning, Mr. Finch. I didn't wantto bother you none. I brung you thesehere hickory nuts as part of myentailment. Well, I thank you.
The collards we had last week were
delicious. Scout, I think maybe, uh, next time Mr.Cunningham comes, you better not callme. I think it embarrasses him to bethanked.
Why does he bring you all this stuff?
He's paying me for some legal work Idid for him.
Why does he pay you like this? That's the only way he can. He has no
money.
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Modern barter
Modern day barter systems: the internet can be
used to provide information about exchange,
which can promote direct (i.e. barter) exchange.An example:
http://www.merchantsbarter.com/
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Functions of money
Money is an asset or store of value that facilitates
exchange. Money is neither income, nor wealth.
Two basic functions of money:
medium of exchangegenerally accepted means
of payment medium or unit of account, or a standard of
value.
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Functions of money
Relative prices
With n goods: n(n-1)/2 relative prices.
n= 5 10; n = 100 4950 relative prices.Under barter, must keep track of all.
With unit of account, only keep track of n-1 prices,and easily compute relative prices. Example:
relative price of apples in terms of oranges is theunit of account price of apples divided by unit ofaccount price of oranges.
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Functions of money
Logically, the medium of exchange function and
unit of account function need not be served by
the same commodity. For example, gold might bemedium of exchange, dollars might be unit of
account.
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Comments
Menger (1871): moneyevolves spontaneously
Most saleable goods: scarce,durable, portable, divisible,
and homogeneous
Cattle one of the first media
of exchange and media of
account; but metals (gold and
silver most commonhistorically)
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Modern money
Paper currency
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Modern money
Paper currency
Checkable deposits at
banks (checking
accounts)
Stored-value cards
Local currencieshttp://www.berkshares.org/
Pay pal?
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Alternatives to money
Credit
Liquid assets Gold and silver?
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Purchasing power of money and
inflation
Purchasing power of money: value in exchange
for other goods: how much a monetary unit canbuy.
Price level: the reciprocal of the purchasingpower of money; the money price of the average
good. Inflation rate: rate of change of price level over
time
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US Price level (CPI)
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US Inflation (CPI)
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Recent US inflation
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Purchasing power of money and
inflation
Hyperinflation: extreme inflation (say greater
than 50% per month). At this rate, $1 item on
Jan. 1 would cost $130 on Dec. 31. German hyperinflation: inflation rate was 322%
per month from August 1922 to November 1923.
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German wholesale price index
Index mon. rate
12/1914 125
12/1921 3,490 4.3%12/1922 147,480 36.6%
12/1923 126,160,000,000,000 455%
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Inflation
Inflation occurs when the quantity of money grows faster than thedemand to hold it. If there is too much money, people try to spendit on goods and services, driving prices up.
Too much money chasing too few goods.
Inflation is always and everywhere a monetary phenomenon.
Hyperinflations occur when money supply growth far exceedsmoney demand growth, as in Post World War I Germany. Such
hyperinflation can only happen with fiat money when money ischeap to produce and there is no anchor for its quantity.
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Measuring the quantity of money
M1 = Currency held outside of banks + checkabledeposits issued by financial institutions + travelers
checks M2 = M1 + plus savings deposits (including moneymarket deposit accounts) and small-denomination (lessthan $100,000) time deposits issued by financialinstitutions; and shares in retail money market mutual
funds (funds with initial investments of less than$50,000), net of retirement accounts.
MZM = M2 + institutional money market mutualfundssmall denomination time deposits.
M1 money stock
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M1 money stock
M1 money stock
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M1 money stock
M2 money stock
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M2 money stock
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Real money balances
M = nominal stock of money (in unit of account)
P = price level
M/P = real money stock; the quantity of money in terms ofits purchasing power, what it can buy.
An example: the real value of $100, if bread is $2 a loaf, is50 loaves of bread.
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A shopping time model of money
Households consume leisure and other stuff
They can shop or consume leisure. Opportunity cost of shopping is leisure.
Shopping time can be reduced by incurring
transactions costs. Optimal shopping time minimizes total costs of
exchange.
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A shopping time model of money
Costs
Shopping
Time
Waiting costs
Transactions costs
Total costs
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A shopping time model of money
Costs
Shopping
Time
Waiting costs
Transactions costs
with barter
Transactions costs
With money