Chapter 10: Money. Stranded, “Cast Away” style 1 Person 1 Person Desert Island Desert Island Fruit Fruit + Animals to eat + Animals to eat Paradise Paradise

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  • Chapter 10: Money

  • Stranded, Cast Away style 1 Person Desert Island Fruit + Animals to eat Paradise + Treasure Chest Useless Trinkets

  • Stranded, Cast Away style You Guy 2Pick Berries Hunt Fish and Animals

  • Stranded, Cast Away style You Guy 2Pick Berries Hunt Fish and Animals Barter the exchange of one good for another, without the use of money.

  • Stranded, Cast Away styleWith more people added to the island, specializations begin to grow. Theres more risk, as people trade for items that might not be wanted at the moment, but are traded anyways hoping to trade in the futurePeople might not trade for things they want. (Ex. Farmer wants meat but Butcher doesnt want wheat)

  • The Invention of MoneyMoney Any commonly accepted good that acts as a medium of exchange, a measure of value, and a store of value.

  • The Invention of MoneyMoney must be Durable long lastingPortable take it anywhereDivisible can be broken down Homogeneous identicalStable supply must be in control

  • The Invention of MoneyFiat Money Paper money that is not backed by or convertible into any good.

  • Greshams Law Law established by Sir Thomas Gresham that explains how bad money drives out good.

    If there are two different kinds of money, one more expensive than the other but valued the same as quantity, the cheaper kind (bad money) would drive out the more expensive one (good money).

  • Greshams LawExample:If there was a more valuable silver quarter and a cheaper copper quarter circulating in the economy, people would over time hoard the silver quarters, making the copper quarters the norm for quarters.

  • Money in the Modern EconomyCurrency Coins and Paper Money

  • Money in the Modern EconomyLiquidity The degree to which an asset can easily be exchanged for money.

    Basically, liquidity is how fast you can convert an asset into money.

  • Money in the Modern EconomyMoney Supply The supply of currency, demand deposits, and travelers checks used in transactions. Basically, its M1.

  • Money in the Modern EconomyM1 Money Supply The supply of the most immediate form of money. It includes currency, demand deposits, and travelers checks.

  • Money in the Modern EconomyM2 money supply M1 money plus savings accounts, mutual funds, deposit accounts, repurchase agreements, and small-denomination time deposits.

    M2 is just M1 plus lesser form of liquid assets.

  • Money in the Modern EconomyM3 money Supply M2 money plus large-denomination time deposits and large-denomination repurchase agreements.

    M3 is M2 plus even less liquid assets.


  • Money in the Modern EconomyThere is no clear line between money and non-money assets. Basically, most assets can be converted into money. =

  • Money FactsThe largest denomination of currency printed today is $100.The Bureau of Engraving and Printing is the agency in charge of printing the currency.All of the U.S. coins currently printed portray past U.S. presidents. Currency printed after 1929 is 6.14 by 2.61

  • Money FactsThe average lifespan of a $1 bill is 12-18 months while the life for a $100 bill is 8-9 years. To stop counterfeiting, U.S. bills are protected by:Tiny red and blue fibers in the paperA polyester strip embedded vertically in the paperSpecial inks.

  • The Quantity Theory of MoneyVelocity of money The average number of times per year each dollar is used to transact an exchange.

  • The Quantity Theory of MoneyEquation of exchange The quantity of money times its velocity equals the quantity of goods and services produced times their prices.

    MV = PQ

  • The Quantity Theory of MoneyThe Classical view: Real GDP (Q) depends on the amount of resources in the economy, which are fixed. Prices are flexible. Velocity is fixed.

    MV = PQ

  • The Quantity Theory of MoneyThe Classical View:Since Q and V are fixed, while P is flexible, the classical view holds that there is a direct relationship between M and P.

    MV = PQFixedFixedFlexible

  • The Quantity Theory of MoneyQuantity Theory of Money The equation specifying the direct relationship between the money supply and prices.

    P = MV/Q

  • The Quantity Theory of MoneyMonetarists attempted to rescue the classical view from evidence showing that M1 velocity is not constant. They argue that if velocity is stable and predictable, and if Q is at full-employment GDP, then the direct relationship between M and P remains intact.


  • Historical Record of Money Velocity(from previous graph)Increased use of credit cards from the 50s to the 80s allowed people to buy more goods and services with less cash and lower demand deposit balances relative to nominal GDP.

  • Quantity Theory of MoneyKeynesians reject the monetarists idea that V is either stable or predictable, and that Q always reflects full-employment GDP. Because of this, changes in M will affect more than just Pthey may also change Q.

  • The Demand for MoneyTransactions demand for money The quantity of money demanded by households and businesses to transact their buying and selling of goods and services.

    Amount of money needed for a household/business to survive

  • The Demand for MoneyThe Classical view is that the transactions demand for money is the only motive for demanding money. If P or Q rises, the transactions demand for money will also rise.

  • The Demand for MoneyThe Keynesian view is that in addition to the transactions demand for money, there is also a precautionary motive and a speculative motive for demanding money.

  • The Demand for MoneyClassicalTransactions demand for money is the only motive for demanding moneyKeynesianThere is a precautionary and a speculative motive for demanding money, when added to the transaction demand


  • The Speculative Demand for MoneyThe quantity of money demanded increase as interest rates decrease because people shift out of interest-paying accounts into holding money because the opportunity cost of holding money has fallen.




  • Money Affects Real GDPAccording to the Keynesian view, a change in the money supply affects Real GDP by:An increase in the money supply reduces interest rates. Lower interest rates increase investment spending. Increased investment spending increases aggregate demand.

  • The Demand for MoneyThe shape of the aggregate supply curve when a change in the money supply affects real GDP and not the price level will look horizontal, where the aggregate demand curve shifts.

  • The Demand for MoneyClassical economists and Monetarists see the shape of the aggregate supply curve as the segment of the aggregate supply curve over which aggregate demand shifts is vertical, and occurs at the full-employment level of real GDP. Thus only prices change, not real GDP.

  • Chapter Review

  • Chapter Review #1Barter exchanges requires a double coincide of wants. As the number of people and the number of goods increase, barter becomes increasingly more difficult. One good then becomes chosen as the barter form. The characteristics of a good money are durability, portability, divisible, homogeneity, and stability. Gold is an exemplary money form.

  • Chapter Review #2Money serves three functionsIt is a medium of exchange A measure of valueA store of valuePaper (or fiat) money can substitute for gold as long as it is universally accepted as the medium of exchange.

  • Chapter Review #3The difference measure of our money supply depends upon the degree of liquidity we use. M1, the most liquid form of money, is essentially currency and checkable deposits such as NOW and ATS accounts. M2 includes M1 plus small-denomination time deposits, such as MMDAs, and savings accounts.M3 include M2 plus large-denomination time deposits and overnight repurchase agreements.

  • Chapter Review #4The equation of exchange is written as MV = PQ. Classical economists believe that because output, Q, is constant at full-employment equilibrium, and because the velocity of money, V, is constant, then the price level in the economy, P, varies directly with the money supply, M.

  • Chapter Review #5Monetarists accept the classical idea that the economy operates at full-employment equilibrium, but unlike the Classicist, they believe that the velocity of money is not constant but nonetheless stable and predictable enough to ensure the usefulness of the equation of exchange linking prices to the money supply.

  • Chapter Review #6Keynesian believe that because output and velocity are neither constant nor stable and predicable, changes in the money supply can affect real GDP as well as prices

  • Chapter Review #7According to to classical economist, the demand for money is strictly a transaction demand. Keynesian, on the other hand, use the transactions, precautionary, and speculative motives as determinants of money demand.

  • Questions & Answers

  • Question #1Why does barter exchange become in