CHAPTER14Money, Banks, and theFederal Reserve SystemChapterOutlineandLearningObjectives14.1WhatisMoney,andWhyDoWeNeed It?14.2HowlsMoneyMeasuredinthe United States Today?14.3HowDoBanksCreateMoney?14.4TheFederalReserveSystem14.5TheQuantityTheoryotMoney
1 Chapter Outline and Learning Objectives 14.1 What is Money, and Why Do We Need It? 14.2 How Is Money Measured in the United States Today? 14.3 How Do Banks Create Money? 14.4 The Federal Reserve System 14.5 The Quantity Theory of Money CHAPTER 14 CHAPTER Money, Banks, and the Federal Reserve System
MoneyMoney is one of the most important inventions of mankind,: Economists consider money to be any asset that people aregenerally willing to accept in exchange for goods and services, orfor payment of debts.. Asset: Anything of value owned by a person or a firm.We will begin by considering what role money serves, and what canbe used as money.Thenwewill considermodernformsofmoneyandtherolesofbanks and the government in creating and managing money.Finally, we will create a model relating prices to the amount ofmoney.@2015Pearson Education,Inc.?
© 2015 Pearson Education, Inc. 2 Money Money is one of the most important inventions of mankind. • Economists consider money to be any asset that people are generally willing to accept in exchange for goods and services, or for payment of debts. • Asset: Anything of value owned by a person or a firm. We will begin by considering what role money serves, and what can be used as money. • Then we will consider modern forms of money and the roles of banks and the government in creating and managing money. • Finally, we will create a model relating prices to the amount of money
WhatIsMoney,and WhyDoWeNeed It?14.1LEARNINGOBJECTIVEDefine moneyanddiscuss thefourfunctions of money@2015PearsonEducation,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 3 What Is Money, and Why Do We Need It? 14.1 Define money and discuss the four functions of money
Barterand the Inventionof MoneySuppose you were living before the invention of money: If you wanted to trade, you would have to barter, trading goods andservices directlyforother goods and servicesTrades would require a double coincidenceofwantsEventually, societies started using commodity money-goods usedas money that also have value independent of their use as money-likeanimal skins orprecious metals.Theexistence ofmoney makes trading mucheasier and allowsspecialization, an important step for developing an economy@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 Barter and the Invention of Money Suppose you were living before the invention of money. • If you wanted to trade, you would have to barter, trading goods and services directly for other goods and services. • Trades would require a double coincidence of wants. Eventually, societies started using commodity money—goods used as money that also have value independent of their use as money— like animal skins or precious metals. • The existence of money makes trading much easier and allows specialization, an important step for developing an economy
TheFunctionsof MoneyMoneyfulfillsfourprimaryfunctions:Medium of exchangeMoney is acceptable to a wide variety of parties as a form of paymentfor goods and services.Unit of accountMoney allows a way of measuring value in a standard manner.Storeof valueMoney allows people to defer consumption till a later date by storingvalue. Other assets can do this too, but money does it particularlywell because it is liquid, easily exchanged for goods.Standard of deferred paymentMoneyfacilitates exchanges acrosstimewhen we anticipatethat itsvalueinthefuturewillbepredictable2015PearsonEducation,Inc.5
© 2015 Pearson Education, Inc. 5 The Functions of Money Money fulfills four primary functions: Medium of exchange Money is acceptable to a wide variety of parties as a form of payment for goods and services. Unit of account Money allows a way of measuring value in a standard manner. Store of value Money allows people to defer consumption till a later date by storing value. Other assets can do this too, but money does it particularly well because it is liquid, easily exchanged for goods. Standard of deferred payment Money facilitates exchanges across time when we anticipate that its value in the future will be predictable
WhatCan ServeasMoney?Inordertoserveas anacceptablemediumofexchange (andhenceapotential “money"), a good should have the following characteristics:1. The good must be acceptable to most people.2. It should be of standardized quality so any two units are alike.3. It should be durable so that value is not lost by storage4. It should be valuable relative to its weight, so that it can easily betransportedeveninlargequantities5.It should be divisible because different goods are valueddifferently.@2015PearsonEducation,Inc.6
© 2015 Pearson Education, Inc. 6 What Can Serve as Money? In order to serve as an acceptable medium of exchange (and hence a potential “money”), a good should have the following characteristics: 1. The good must be acceptable to most people. 2. It should be of standardized quality so any two units are alike. 3. It should be durable so that value is not lost by storage. 4. It should be valuable relative to its weight, so that it can easily be transported even in large quantities. 5. It should be divisible because different goods are valued differently
CommodityMoneyCommodity money has a value independent of its use as money.Some important historical and modern commodity moneys:· Cowrie shells in Asia (the Classical Chinese character formoneylcurrency, , originated as a pictograph of a cowrie shell: Precious metals, such as gold or silverBeaverpelts inpre-colonial America:Cigarettes in prisons and prisoner-of-war camps@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 7 Commodity Money Commodity money has a value independent of its use as money. Some important historical and modern commodity moneys: • Cowrie shells in Asia (the Classical Chinese character for money/currency, 貝, originated as a pictograph of a cowrie shell) • Precious metals, such as gold or silver • Beaver pelts in pre-colonial America • Cigarettes in prisons and prisoner-of-war camps
FiatMoneyBeginning in China in the 1oth century and spreading throughout theworld, paper money was issued by banks and governments. Thepaper money was exchangeable for some commodity, typically goldon demand.In moderneconomies,paper moneyis generallyissued by a centralbank run by the government.TheFederal Reserveisthecentral bankoftheUnitedStatesHowever,moneyissuedbytheFederalReserve isno longerexchangeable for gold; nor is any current world currency. Instead, theFed issues currency known as fiat money.Fiat money refers to any money, such as paper currency, that isauthorized by a central bank or governmental body, and that does nothavetobe exchangedbythecentral bankfor goldor some othercommodity money.82015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 8 Fiat Money Beginning in China in the 10th century and spreading throughout the world, paper money was issued by banks and governments. The paper money was exchangeable for some commodity, typically gold, on demand. In modern economies, paper money is generally issued by a central bank run by the government. The Federal Reserve is the central bank of the United States. However, money issued by the Federal Reserve is no longer exchangeable for gold; nor is any current world currency. Instead, the Fed issues currency known as fiat money. Fiat money refers to any money, such as paper currency, that is authorized by a central bank or governmental body, and that does not have to be exchanged by the central bank for gold or some other commodity money
Fiat MoneyAdvantagesand DisadvantagesFiat money has the advantage that governments do not have to bewillingto exchangeitforgoldor some other commodityon demand.. This makes central banks more flexible in creating moneyHowever it also creates a potential problem: fiat money is onlyacceptable as long as households and firms have confidence that iftheyacceptpaperdollarsinexchangeforgoodsand services, thedollars will not lose much value during the time they hold them.. If people stop“believing" in the fiat money, it will cease to beuseful.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 9 Fiat Money—Advantages and Disadvantages Fiat money has the advantage that governments do not have to be willing to exchange it for gold or some other commodity on demand. • This makes central banks more flexible in creating money. However it also creates a potential problem: fiat money is only acceptable as long as households and firms have confidence that if they accept paper dollars in exchange for goods and services, the dollars will not lose much value during the time they hold them. • If people stop “believing” in the fiat money, it will cease to be useful
MakingApple Didn't WantMy Cash!theConnectionA woman in California wentto anApple store and tried to buy aniPad using $600 in currency· Apple refused the sale.Itwanted to keep track of peoplebuying multiple iPads to resell.so itwasonlyacceptingcreditor debit cards.Can Apple do this legally? Yes! Firms are not obliged to acceptcurrency as payment. (Debts are a different story.)· Similarly, many convenience stores and gas stations refuse totake large-denomination bills (s50 or more).Nor can you force astore to accept a bucket of pennies as payment.Due to bad publicity, Apple ended up giving the woman (who was inawheelchair!)aniPadforfree102015PearsonEduction,Inc
© 2015 Pearson Education, Inc. 10 Making the Connection Apple Didn’t Want My Cash! A woman in California went to an Apple store and tried to buy an iPad using $600 in currency. • Apple refused the sale. It wanted to keep track of people buying multiple iPads to resell, so it was only accepting credit or debit cards. Can Apple do this legally? Yes! Firms are not obliged to accept currency as payment. (Debts are a different story.) • Similarly, many convenience stores and gas stations refuse to take large-denomination bills ($50 or more). Nor can you force a store to accept a bucket of pennies as payment. Due to bad publicity, Apple ended up giving the woman (who was in a wheelchair!) an iPad for free