AP MacroeconomicsUnit 3The Financial SectorVocab: Ch. 31/32Exam Dates: 3/27 and 3/28

Money and Assets• Q: What characteristics of a dollar bill makes it a good

form of money?

• It all used to be a barter system…

• Gold, silver, jewelry, tobacco, beer, cattle, metal coins, paper bills, checks, etc.

• Became too inefficient: Double coincidence of wants

• Too time consuming and could hinder large economic development…so…

• Money facilitates trade and makes it more efficient.

Money and Assets• Money has 3 functions in an economy:

1. Medium of Exchange: Money is used to trade for goods/services, is accepted by all, is portable, and is divisible for big and small transactions.

2. Store of Value: Holds purchasing power over time and is stable in value.

3. Unit of Account (Standard of Value): Used as a measure to set prices (i.e. Measure distance in miles and value of commodities in dollars)

• Commodity vs. Fiat Money

Defining and Measuring the Money Supply

• Liquidity: the ease by which an asset can be turned into cash.

• Asset: A resource with economic value with the expectation that it will provide future benefit (i.e. investments, stocks and bonds, etc.)

• Money Supply: The entire stock of currency and other liquid assets in a country's economy at a particular time. 

• The Federal Reserve (U.S. Central Bank) must provide a definition of what is included as money.

Defining and Measuring the Money Supply

• The Fed uses monetary aggregates to determine the money supply:

1. M0 = Paper currency (Federal Reserve Notes) and coins (U.S. Treasury)

2. M1 = M0 + demand deposits (checkable deposits, Negotiable Order of Withdrawal account (NOW )

• Most liquid components used to quantify amount of money in circulation.

• M1 is a measure of money that can be directly used for transactions.

Defining and Measuring the Money Supply

• M2 = M0 + M1 +…

• Savings deposits

• Money Market shares (interest bearing accounts with minimum balance requirements and withdrawal limits)

• Small Time deposits- less than $100,000 (CD- Certificate of Deposit issued by banks and credit unions.)

• M2 = M1 + several Near Monies: Highly liquid financial assets.

• Note: Each category becomes broader- it includes the previous category plus additional forms of money.

• Note: M0 and M1 are used as medium of exchanges and M2 are used as store of value.

Financial Assets• Financial Markets: Facilitate

funds from lenders to borrowers- Households invest savings in financial assets.

• Financial Markets serve 3 functions:

1. Reduce transactions costs by matching borrowers and lenders.

2. Reduce the risk taken by lenders (diversification of portfolio.)

3. Provide liquidity (access to cash) through financial intermediaries.

• Financial Asset: A paper claim that entitles its buyer to future income from the seller.

• 4 types of financial assets…

1. Stock: Share in the ownership of a company

2. Bond: IOU issued by borrower with promise to pay fixed interest payments at regular intervals and repay principal on specified date.

3. Loan: Agreement to repay plus interest

4. Bank Deposits: Money placed into a banking institution for safekeeping (Savings, checking, money market accounts.)