Chapter 9 Money in the U. S. Economy © 2001 South-Western College Publishing

2 Definition of Money 4 Money is a medium of exchange 4 Anything generally accepted in exchange for other goods and services

3 Functions of Money 4 Standard of value 4 Medium of exchange 4 Store of value 4 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 4 Money Stock: quantity of money in circulation at any given time 4 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 4 Currency: paper money and coins 4 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 4 Savings Deposits: interest-bearing funds held in accounts that do not allow for automatic transfer services 4 Time Deposits: funds that earn a fixed rate of interest and must be held for a stipulated period of time 4 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 4 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 = PQ where M = total money supply V = velocity of money P = price level or average price per transaction Q = 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 S  Balanced gov. budget  Exports = Imports  Stable money supply Conditions Tending toward Decrease in Total Output and/or Decline in Price Level  Planned I < Planned S  Surplus gov. budget  Net imports  Decrease in money supply Conditions Tending toward Increase in Total Output and/or Increase in Price Level  Planned I > Planned S  Deficit gov. budget  Net exports  Increase in money supply

13 Creation of Money 4 Bank deposits are made 4 Banks provide loans 4 Reserve requirements 4 Multiple expansion of the money supply 4 Contraction of the money supply

14 Money Multiplier The money multiplier is the reciprocal of the reserve ratio.

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

16 Consumer Price Index (CPI) 4 CPI: 4 CPI: index that compares the price of a group of basic goods and services as purchased by urban residents 4 Components of the CPI 4 Limitations of the CPI 4 CPI and COLA (cost of living adjustment) 4 CPIs of other countries

17 Producer Price Index (PPI) Measure of the average prices received by producers and wholesalers

18 Real Income 4 The constant dollar value of goods and services produced 4 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