Post on 29-Dec-2015
Chapter 11
Money
Money
MONEY (def): any commodity or token that is generally acceptable as a means of payment
What are the functions of money What does money do?
What are the characteristics of money? What can be used as money?
What’s it worth? Yasin’s Shirt?
Sammy’s Shoes?
Grace’s watch?
Taylor’s Phone?
The 3 Functions of money
Medium of Exchange Measure of value Store of value
Medium of Exchange
Before, money economies worked on a barter system (trading)
Barter system works on double coincidence of wants – seller and buyer must both be willing
In Medium of Exchange Money acts as a lubricant that smoothes the
mechanism of exchange Everybody wants currency because they can use it
to get what they want
Medium of Exchange
Saves time over bartering When you barter it takes time to find someone
that has what you wanted and wanted what you have.
With medium of exchange – you sell to any willing buyer and buy from any willing seller for currency
Purchasing Power: The amount of goods or services that can be bought with a unit of currency
Measure of value or Unit of Account
Allows Prices Standard prices allow commerce to move
faster haggling
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Measure of value or Unit of Account
Allows Price comparison, which allows decisions In the barter system the value of a good is worth the
value of many other goods. 1 chicken equals so many loaves of bread, so many litres of milk,
pounds of cheese etc.
In a money system, there is a unit of currency that acts as the “standard” that can be used to measure against.
Money makes comparison easy An Ipad = $600 and a PS4 = $600 therefore they are the
same price and are of equal value. A movie is $10 and an DQ blizzard is $5. A DQ blizzard is half
the price of a movie.
Store of Value
In the barter system one good is sold in place of another good.
Money however, can be held (saved) to delay consumption Money as well as other assets such a jewellery, real estate,
antiques. However money has the greatest level of liquidity. Purchasing power in the future should be close to the
purchasing power today Inflation is the rate by which money looses its purchasing
power How leaky is the batery
Canada has established a policy to control inflation to approximately 2%. This assists in the control of purchasing power.
Store of Value
Store of value is very important in international trade
People will look for safe harbours currencies during times of political or economic turmoil
Traditional Safe Currencies USD Euro CAD
The Big FIVE characteristics of money:
1) generally acceptable 2) portable 3) divisible 4) hard to duplicate or counterfeit 5) uniform in value
1) generally acceptable
Older forms of money was generally acceptable because it had some form of underlying value i.e. Gold Coins
Fiat (let it be so) money is declared by government to be considered legal tender
2) Portable Money should be easy to carry Gold other precious metals were
heavy and dangerous to carry Led to the creation of paper money http://player.discoveryeducation.com/index.cfm?guidAssetId
=E09A70EE-C52E-43E7-9736-6FD5B7B6CA0C&blnFromSearch=1&productcode=US
3) Divisible• Making Change back
in the day
3) Divisible• In order for currency to be useful it had to be divisible to
reflect a range of valuesCanada• 1 dollar = 100 centsBritain• 1 pound = 20 shillings = 240 pence = 960 farthingIndia• 1 gold mohur = 15 silver rupees • 1 ruppee = 16 annas = 64 paise = 192 pies,
4) Hard to Counterfeit Rare It’s a simple tool to help you
remember how to check bills: Touch, Tilt, Look through, Look at.
http://videos.howstuffworks.com/howstuffworks/54-how-money-is-made-video.htm
5) Uniform Value Durable Does not loose it’s value
Inflation
Meet Cupad, Cupid's greedy cousin Counterfeit Uniform in value Portable Acceptable Divisible
Classwork P251 1-4
Fake Money http://bankofcanada.ca/en/
video_corp/videos.html
Measuring the money supply Money: Medium of Exchange Near Money: Deposits or other
assets that act as a store of value but are not themselves a medium of exchange
Components of the Money Supply Demand Deposits
Money will be transferred “on demand”1. Chequing Accounts2. Current Accounts (chequing account for
business)3. Savings Accounts
Term Deposits Lender agrees to lend money for a fixed
amount of time At maturity holder will receive money plus
interest Ex Bonds and GIC (Guaranteed Investment
Certificate)
Components of the Money Supply Notice Accounts
Require notice to the bank before given withdraw
Used primarily by business Some interest paid
Calculating the money supply There are many different measures of Canada’s
money supply Definitions go from narrow (M1) to broad (M2) The narrowest definition is most easily affected
by monetary policy and assets are most liquid The broadest definition is the least affected by
monetary policy and assets are least liquid There is not correct measure of money supply
Definition of the Money Supply Bank of Canada (BOC) has a range of definitions of money
supply ranging from very specific to broad (M1-M3)
M1: Narrowest definition of money – medium of exchange More easily controlled by monetary policy Most liquid
All currency in circulation outside of banks Chequing Accounts and Current Accounts Money in banks and ATMS are not counted because??
M2: Includes all of M1 plus Savings accounts Term Deposits
Definition of the Money Supply M2++: Includes all of M2 plus – store
of value Deposits at non-bank deposit-taking
institutions (credit union, caisse populaires)
Annuities at life insurance companies (Annuities is a mortgage in reverse)
All of these assets can be turned into cash in two business days
Definition of the Money Supply M3: Includes all of M2++ - store of
value Least controlled by monetary policy Least liquid
Large term deposits Foreign Reserves Funds that are used as a Store of value but
can be converted into cash
Why do we care about money supply? Knowing the money supply
Helps BOC determine interest rates and other financial policies
How much money is in Canada?
Money Supply In Canada$Millions
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
2004 2005 2006 2007 2008
M3
M2
M1
Banking System Unit Banking: Many independent
banks limited number of branches US has over 14 000 banks
Branch Banking: Limited number of banks with unlimited number of branches Canada has 13
Branch Banking SystemAdvantages
• Safe – less risk of a run on the bank
Disadvantage
• Highly concentrated in few hands
• Little competition
• Higher costs for consumers
Run on the Bank Occurs when a large
number of customers withdraw their deposits because they believe that the bank might become insolvent (go out of business)
Driven by fear and panic
Canada’s Banks 6 banks control over 90% of the
banking assets
Legal Classification Schedule I banks: Domestic Banks
The 13 Chartered Banks Schedule II Banks: Canadian Banks that
are subsidiaries of foreign Banks HSBC Canada Citibank Canada
Schedule III Banks: Foreign Banks with branches in Canada Deutsche Bank
MAGIC or COUNTERFEIT?
How does a Bank turn $100 into $1000?
Reserve Ratio
Reserve requirement is a regulation that sets the minimum reserves each bank must hold to customer deposits and notes Ex. The reserve ratio is 5% A deposit of $100
$5 Reserve $95 Can be loaned out
Reserve Ratio Ex Reserve Ratio: 10% Tarek deposits $100 in the bank The bank keeps $10 and lends out $90 to Thea Thea uses the $90 to pay her employee Sammi who then
deposits the money in the bank The bank keeps $9 and lends out $81 to Sandra who
purchases supplies from Eric for supplies for her new fashion boutique
Eric deposits the $81 in the bank The bank keeps $8.10 and lends out $72.9 to Saheel who
buys books for school from Casey’s Book Store Casey deposits the $72.9 in the bank The bank keeps $7.29 in reserve and lends out $65.61 to
Gordon to help him pay to record his new country song "your love hurts like a broken toe"
Reserve Ratio Ex
$100 Could result in a maximum of $1000
in new money
Reserve Ratios around the world India: 5% China: 15.5% United States: 10% Chile: 4.5% South Africa: 2.5% Canada: ?
260 Example 1
Change in Deposits =
1_____________________________
Reserve Ratio
x Change in Reserves
Change in Deposits =
1_____________________________
0.1x 100
Change in Deposits = 1000
Change in Money Supply
= 900
260 Example 2
Change in Deposits =
1_____________________________
Reserve Ratio
x Change in Reserves
Change in Deposits =
1_____________________________
0.05x 500
Change in Deposits = 10 000
Change in Money Supply
= $9 500
In Class work Do Questions 1-3 (don’t do #4) on
page 260
260 1
Change in Deposits =
1_____________________________
Reserve Ratio
x Change in Reserves
Change in Deposits =
1_____________________________
0.1x 5 000
Change in Deposits = 50 000
Change in Money Supply
= 50 000 – 5 000 = 45 000
260 2
Change in Deposits =
1_____________________________
Reserve Ratio
x Change in Reserves
Change in Deposits =
1_____________________________
0.08x 10 000
Change in Deposits = 125 000
Change in Money Supply
= 125 000 – 10 000 = 115 000
P260 3
Change in Deposits =
1_____________________________
Reserve Ratio
x Change in Reserves
Change in Deposits =
1_____________________________
0.20x 1000
Change in Deposits = 5 000
Change in Money Supply
= 1000 – 5000 = - 4000
Assets and Liability A deposit in the bank is both:
Asset (something of value) Liability (a debt that has to be repaid)
Assets always equal liabilities (+ owner’s equity)
Creation of money in multi-bank system (p257) Scenario:
Bank A has deposit of $10 000 $1000 Reserve (10%) $9000 Excess
Ms Yeung borrows $9 000 Ms Yeung buys furniture worth $9 000 The store deposits the money Bank B
$900 Reserve (10%) $8100 Excess
Mr Papas borrows $8100 Mr Papas gives that money to another person who
deposits it in bank C $810 Reserve (10%) $7290 Excess
Creation of money in multi-bank system (p257) A multibank system will result in the
same amount of new money creation as a monopoly bank so long as the reserve ratios is the same
Creation of money in multi-bank system (p257) Reserve ratio: 10% Deposit: $10 000 New money: ?
Creation of money in multi-bank system (p257) Reserve ratio: 10% Deposit: $10 000 New money: A MAXIMUM OF $90 000 Why a maximum?
A bank might not lend out all of its excess reserves ( High interest, Prudent lending)
Cash Drain People holding (hoarding) money outside of the banking system
Creation of money in multi-bank system
Bank A
Assets LiabilitiesCash +$10000
(Required 1000
Excess $9000)
Deposit+$10000
Total $10000
Total $10000
Bank A - Loan
Assets Liabilities
Cash $10000
Loan +$9000
Initial $10000
New +$9000
Total $19000
Total $19000
Creation of money in multi-bank systemBank A - Withdrawal
Assets Liabilities
Cash $1000
Loan $9000
Deposit $10000
Total $10000
Total $10000
Bank B - Deposit
Assets LiabilitiesCash $9000
(Required $900
Excess $8100)
Initial $9000
Total $9000
Total $9000
Creation of money in multi-bank system
Bank C - Deposit
Assets LiabilitiesCash $8100
(Required $810
Excess $7290)
Deposit $8100
Total $8100 Total $8100
Bank B - Loan
Assets Liabilities
Cash $9000
Loan $8100
Initial $9000
New +$8100
Total $17100
Total $17100
How banks Destroy “money” The amount of money destroyed is
calculated in the same way as money is created
How banks Destroy “money”
Bank A
Loss of Deposit
Assets Liabilities
Cash -10000
Loan -9000
Deposit -10000
Total -10000 Total -10000
Bank A
Loss of Loan
Assets Liabilities
Loans -9000
Cash +9000
Deposit
Total 0 Total 0
In class work Pg. 260 #4
P260 4Bank A
Assets Liabilities
Cash -2000
Loan -8000
Deposit -10000
Total -10000 Total -10000
Bank B
Assets Liabilities
Cash -1600
Loan -6400
Deposit -8000
Total -8000 Total -8000
How Banks Destroy Money Someone withdraws money
Bank has a shortfall and must find money to complete the withdraw
Bank relies on loans being paid back Banks ceases lending if necessary
This is why banks significantly restricted lending in the US during the 2008 – 2009 recession
Read P249-254
Answer Questions #1-3 on page 251 Answer Questions on page 261
#1,2,3,4a
Answers to p.251 #1-3 1) medium of exchange is the most
important because money does away with barter. It is for this reason that money was developed. The other 2 functions stem from that same essential function: money must be accepted as a medium before it can serve as a measure and a store of value
2) The store value function is undermined most severely by inflation, because money loses its buying power
3 a) Liquidity is the ease with which and asset can be used to make a payment, money being the most liquid of assets
B) Canada Savings Bond; shares in a large corporation. The other three follow in no particular order; they depend upon whether buyers can easily be found who will pay for them.
Pg. 261 #1) U.S is much more limited in the number
of branches they are allowed. In the past Canada’s branch system gave security to the banks, because one branch could support another experiencing difficulties. Today both Canadian and US banks have deposit insurance in case of bank failures, therefore lessening the degree of advantage of security that the Canadian branch system has for depositors.
Pg. 261 #2) The tendancy is that depositors seldom
withdraw the total amount they have deposited, leaving most of their deposits as excess reserves, which can be used for lending
#3) it becomes an asset for the bank because the bank owns it and can use it; it becomes a liability because the bank owe the amount to the depositer
#4 A $5,000 deposit in a monopoly bank allows a loan of $45,000; an $18,000 deposit allows a loan of $162,000
Classwork P251 1-3
1. Most essential function of money?2. Store of value, a lifetime of saving can be
destroyed by inflation1. Diversify your portfolio
3. Liquidity is the ease which an asset can be converted to cash
1. Canada Savings Bond2. Share in a large corporation3. Gold Jewelry4. Diamond ring5. Rare Painting