MoneyEconomics Chapter 10 Section 1

What is Money?

• Money is anything that serves as

– A medium of exchange

– A unit of account

– A store of value.

Money as Medium of Exchange

• A medium of exchange is anything that is used to determine value during the exchange of goods and services.

• Without money, people would barter for goods– Trade one good for another

– Stilled used in many countries today

Money as a Unit of Account

• A unit of account is a means for comparing the values of goods and services. – You will check prices to

find the best deals

Money as a Store of Value

• A store of value is something that keeps its value if it is stored rather than used.

• There is an exception

– Inflation will not all money to act as a store of value

The coins and paper bills used as money in a society are called currency. A currency must meet the following characteristics:

DurabilityObjects used as money must withstand physical wear and tear.

PortabilityPeople need to be able to take money with them as they go about their business.

DivisibilityTo be useful, money must be easily divided into smaller denominations, or units of value.

UniformityAny two units of money must be uniform, that is, the same, in terms of what they will buy.

Limited SupplyMoney must be available only in limited quantities.

AcceptabilityEveryone must be able to exchange the money for goods and services.

The Six Characteristics of Money

The Sources of Money’s Value:Commodity Money

• Commodity money consists of objects that have value in themselves.

– Gold

– Silver

– Copper

• They all have other uses than just money

The Sources of Money’s Value:Representative Money

• Representative money has value because the holder can exchange it for something else of value.

– Think exchanging currency for gold and silver

The Sources of Money’s Value:Fiat Money

• Fiat money, also called “legal tender,”

– Has value because the government decreed that is an acceptable means to pay debts.

– Think currency exchange from different countries

The History of American BankingEconomics Chapter 10 Section 2

Two Views of Banking

FEDERALISTS

• Federalists believed the country needed a strong central government to establish economic and social order.

• Alexander Hamilton was in favor of a national bank – Could issue a single currency

– Handle federal funds

– Monitor other banks

ANTIFEDERALISTS

• Antifederalists were against a strong central government– Favored leaving powers in the

hands of the states.

• Thomas Jefferson opposed the creation of a national bank– Favored banks created and

monitored by individual states.

Banking In The 20th Century

• The Federal Reserve Act of 1913 – Created the Federal Reserve

System. – The Federal Reserve System

served as the nation’s first true central bank.

• The Banking Act of 1933– Created the Federal Deposit

Insurance Corporation (FDIC).– The FDIC insures customers’

deposits up to $100,000. – The nation was also taken off

of the gold standard.• Federal Loans back money up

today

Banking TodayEconomics Chapter 10 Section 3

Demand for money has an inverse relationship

between interest rates and the quantity of money

demandedWhat happens to the quantity

demanded of money when interest

rates increase?

• Quantity demanded falls

• People don’t want to pay

interest on the loaning of

money

• People would rather earn

interest on saving money

What happens to the quantity

demanded when interest rates

decrease?

• Quantity demanded

increases

• There is no incentive to

convert cash into interest

earning assets (Saving

Accounts)

Other Shifters in money demand

• Changes in banking technology (ex: ATM’s)

• Changes in Banking Institution Regulations

• Changes in Real GDP

Nominal Interest Rate (ir)

Quantity of Money(billions of dollars)

20%

5%

2%

0DMoney

Inverse relationship between interest rates and the quantity of money demanded

The Demand for Money

Quantity of Money(billions of dollars)

20%

5%

2%

0DMoney

What happens if price level increase?

The Demand for Money

DMoney1

Money Demand Shifters1. Changes in price level2. Changes in income3. Changes in taxation that

affects investment

Nominal Interest Rate (ir)

The Money Supply

• The money supply is all the money available in the United States economy.

• This can be measured in two ways

– M1

– M2

M1

• M1 consists of assets that have liquidity, or the ability to be used as, or easily converted into, cash.

– Currency

– Traveler’s checks

– Demand deposits (Checking Accounts.

M2

• M2 consists of all of the assets in M1, plus:– Deposits in savings

accounts

– Money market mutual funds.

• A money market mutual fund is a fund that pools money from small investors to purchase government or corporate bonds.

200

DMoney

SMoneyThe FED is a nonpartisan

government office that sets and adjusts the money supply to adjust

the economy

This is called Monetary Policy.

The U.S. Money Supply is set by the Board of Governors of the Federal Reserve System (FED)

The Supply for Money

20%

5%

2%

Quantity of Money(billions of dollars)

Interest Rate (ir)

If the FED increases the money supply, a temporary surplus of money will occur

at 5% interest.The surplus will cause the

interest rate to fall to 2%

Increasing the Money Supply

Increase money supply

Decreases interest rate

Increases investment

Increases AD

200

DM

SM

10%

5%

2%

Quantity of Money(billions of dollars)

Interest Rate (ir)

How does this affect AD?

250

SM1

If the FED decreases the money supply, a temporary shortage

of money will occur at 5% interest.

The shortage will cause the interest rate to rise to 10%

Decreasing the Money Supply

Decrease money supply

Increase interest rate

Decrease investment

Decrease AD

200

DM

SM

10%

5%

2%

Quantity of Money(billions of dollars)

Interest Rate (ir)

How does this affect AD?

150

SM1

Banking Services

Storing MoneyBanks provide a safe, convenient place for people to store their money.

Credit CardsBanks issue credit cards — cards entitling their holder to buy goods and services based on each holder's promise to pay.

Saving MoneyFour of the most common options banks offer for saving money are:1. Savings Accounts 2. Checking Accounts3. Money Market Accounts 4. Certificates of Deposit (CDs)

LoansBy making loans, banks help new businesses get started, and they help established businesses grow.

MortgagesA mortgage is a specific type of loan that is used to purchase real estate.

BANK

How Banks Make a Profit

Deposits from customers

Interest from borrowers

Fees for services

Money enters bankMoney leaves bank

Interest and withdrawals to

customers

Money loaned to borrowers:• business loans*home mortgages*personal loans

Bank’s cost of doing business:• salaries• taxes• other costs

Bank retains required reserves

How Banks Make a Profit• The largest source of income for banks is the interest they receive from customers who have

taken loans.

• Interest is the price paid for the use of borrowed money.

• To make more money a bank will pay out less in interest on deposits than it earns in interest on a loan

Types of Financial Institutions

Commercial Banks

• Commercial banks offer checking services, accept deposits, and make loans.

– Citigroup

– Bank of America

– HSBC Bank

– Barclays Bank

Savings and Loan Associations

• Savings and Loan Associations were originally chartered to lend money for home-building in the mid-1800s.

– They work primarily with mortgages and deposits

– Give higher interest rates than commercial banks

• Washington Mutual is an example

Savings Banks

• Savings banks traditionally served people who made smaller deposits and transactions than commercial banks wished to handle.

– They perform the same functions as a commercial banks

Credit Unions

• Credit unions are cooperative lending associations for particular groups

– Usually employees of a specific firm or government agency

– Students of a University• MSU Federal Credit Union

Finance Companies

• Finance companies make installment loans to consumers.

• They provide banking duties without being considered a bank

• They are held to the same regulations as banks

Electronic Banking

• ATM

• Debit Cards

• Direct Deposit

– (Automatic Clearing Houses)

• Home Banking

• Store Value Cards

– (Gift Cards)