Chapter 9

Money in the U. S. Economy

© 2001 South-Western College Publishing

2

Definition of Money

Money is a medium of exchange Anything generally accepted in

exchange for other goods and services

3

Functions of Money

Standard of value Medium of exchange Store of value Standard of deferred payment

4

Double Coincidence of Wants

In a barter economy, the need to find a match between what each of two traders wants to obtain and what each wants to offer in exchange

5

Measuring the Money Supply

Money Stock: quantity of money in circulation at any given time

Liquidity: the ease with which an asset can be converted into the medium of exchange

6

M1 Money Stock

M1 Money Stock: most liquid definition of money that includes currency, travelers checks, and checkable deposits

Currency: paper money and coins Checkable Deposits: checking deposits at

banks and other depository institutions

7

M2 Money Stock

M2 Money Stock: the total of M1 and savings deposits, small time deposits, and money market funds

Savings Deposits: interest-bearing funds held in accounts that do not allow for automatic transfer services

Time Deposits: funds that earn a fixed rate of interest and must be held for a stipulated period of time

Money Market Funds: deposits held in accounts invested in a broad range of financial assets

8

M3 Money Stock

M3 Money Stock: the total of M2, large negotiable certificates of deposit, and Eurodollars

Eurodollars: U.S. dollars deposited in foreign banks and therefore outside the jurisdiction of the U. S.

9

Equation of Exchange

A very simple relationship between the supply of money and the price level

MV = PQMV = PQwhere

M = total money supplyV = velocity of moneyP = price level or average price

per transactionQ = total transactions in the economy

10

Transactions Approach

Analysis of the equation of exchange that assumes any money received is spent directly or indirectly to buy goods and services

11

Quantity Theory of Money

Classical view of the nature of money as being passive, so the quantity of money and the price level are proportional when other conditions are stable

12

Money and the Circular Flow: Relationships of Investment, Savings, Government Budget,

and Money Supply

Conditions Tending toward Stable

Total Output and Stable

Price Level

Planned I = Planned SBalanced gov. budgetExports = ImportsStable money supply

Conditions Tending toward Decrease

in Total Output and/or Decline in

Price Level

Planned I < Planned SSurplus gov. budgetNet importsDecrease in money

supply

Conditions Tending toward Increase

in Total Output and/or Increase in

Price Level

Planned I > Planned SDeficit gov. budgetNet exportsIncrease in money

supply

13

Creation of Money

Bank deposits are made Banks provide loans Reserve requirements Multiple expansion of the money supply Contraction of the money supply

14

Money Multiplier

The money multiplier is the reciprocal of the reserve ratio.

ratio reserve Required1 multiplier Money

15

Price Index

Measuring system for comparing the average price of a group of goods and services in one period of time with the average price of the same group of goods and services in another period

100%period base inbasket market of Price

yeargiven a inbasket market of Price

16

Consumer Price Index (CPI)

CPI:CPI: index that compares the price of a group of basic goods and services as purchased by urban residents

Components of the CPI Limitations of the CPI CPI and COLA (cost of living adjustment) CPIs of other countries

17

Producer Price Index (PPI)

Measure of the average prices received by producers and wholesalers

18

Real Income

The constant dollar value of goods and services produced

The purchasing power of money income

19

Effects of Changes in Price Level

Inflation is– an advantage to those whose incomes increase

faster than the price level– a disadvantage to those whose incomes

decrease faster than the price level– a disadvantage to those whose incomes remain

stable when price level increases– an advantage to debtors– a disadvantage to creditors