“money, money, money, must be funny -- in a rich man’s world” abba
TRANSCRIPT
Money Money
“money, money, money, must be funny -- in a rich man’s
world” Abba
What does money do?1. Medium of Exchange
- it is used to transfer wealth from one person to another
- removes the need for bartering
- money can be anything that is readily and widely accepted by the people of society.2. Measure of Value
- prices of all goods and services are presented in units of dollars.
- it can also be compared to other currencies around the world through exchange rates.
What does money do?3. Store of Value
- Can save money for future purchases
- must take into consideration inflation which makes stored money less valuable
4. Stadard of Debts
- debts over a period of time can be paid with money -- value will continue over a long period of time.
Characteristics of Money
1. Identical - in units of specific value (cents $)
2. Divisible - pennies, nickels, dimes, quarters, etc.
3. Portable - easily carried and transferred
4. Durable - made of metal or strong paper
5. Acceptable - everyone agrees that it be a medium of exchange
Demand for MoneyIt is like any other commodity; it is
affected by supply and demandthere are 3 main reasons people
demand or want to hold money, apart from having it on hand to buy the goods and services needed immediately:
Transactions Motive - money held to finance immediate purchases (example - bills and coins in your wallet; mortgage, groceries,etc.)• the greater the incomes, the greater the
transactions desired. If total national income rises, then transaction demand increases as well
Precautionary Motive - money is held in case of emergenceis or unexpected situations. As the level of income increases, a person’s ability to hold money for emergencies increases as well.
Speculation Motive - interest rates affect the opportunity cost of holding money. As interest rates increase, people are unwilling to borrow money to spend and will place any extra money in intrest bearing assets (bonds). As interest rates decrease, the opportunity cost of holding the money decreases and people are more willing to spend their money or borrow (demand for money increases).
Transactions Demand
+
Precautionary Demand
+
Speculative Demand
=
Total Demand For Money
Demand for MoneyThe demand for money is known
as liquidity preference -- a willingness to make assets liquid or to convert to cash.
Interest rates represent the price or cost of cash -- as interest rates fall, the demand for cash increases -- as interest rates increase, the demand for cash decreases.
I1
Q1
Quantity of Money (dollars)
Inte
rest
Rate
%
I2
Q2
As interest rates decrease, the opportunity cost of holding money increases, and the quantity of money demanded increases.
Demand for MoneyChanges in Real GDP affect the demand
for money -- as real GDP varies, real income varies. The higher our incomes, the more people will spend and thus the greater the demand for money
Price level affects the demand for money -- as price increases, you will need more money to finance your expenditures, therefore causing an increase in the quantity of money demanded.
Definitions of Money in Canada
Money supply in Canada is represented by the total value of coins and paper currency in circulation outside of the banks:
M1
Currency outside the banks + demand deposits at the chartered banks - government deposits
M2
M1 + personal savings accounts + non-personal notice deposits (chartered banks)
M3
M2 + all other deposits (long-term, foreign) at chartered banks
M2+
M2 + all deposits at trust and mortgage loan companies, credit unions.
Near Money
assets which could be easily converted into bank deposits or cash (eg. Canada Savings Bonds)
Equilibrium in the Money Market
Equilibrium in the money market occurs at the intersection of the money demand and money supply curves
The money supply • is a set amount determined by
government decision- makers• is represented by a schedule or vertical
curve
The equilibrium interest rate is inversely related to the money supply
Ie
Sm
Quantity of Money (billions)
Nom
inal In
tere
st R
ate
%
When the nominal interest rate exceeds its equilibrium value, the quantity of money supplied exceeds quantity demanded. This surplus leads to more buying of bonds, forcing bond prices up and the nominal interest rate down, until the quantity of money demanded and supplied are the same. When the nominal interest rate is below its equilibirum value, the opposite occurs. A shortage of money pushes the interest rate up until the equilibrium point is reached.
Equilibrium in the money market
Dm
5
4
3
2
1
0 10 20 30 40 50 60 70 80
Surplus
Shortage
Money Creation
Until 1994, banks had to keep back reserves of cash that could not be used for loans
Now, only desired reserves are kept -- enough to satisfy anticipated withdrawals
Banks hold a certain portion of deposits in the form of cash reserves -- reserve ratio.
Reserve Ratio = Desired reserves
Deposits
Money Creation
Money Creation
Banks sometimes exceed desired levels -- this is called excess reserves.
Excess Reserves = cash reserves - desired levels
Money Creation Process
Suppose a person was given $1000. They put this in their bank account for future use. The bank has a reserve of 10%.
• Deposit $1000• Reserve $ 100• Loan #1 $ 900 Paid to someone who
deposits it into their bank
Money Creation Process
Deposit $900Reserve $ 90Loan #2 $810
Deposit $810Reserve $ 81Loan #3 $729
Paid to someone who will deposit it into their bank
This process will continue until all of the money is used
The Money Multiplier
The money multiplier is the value by which the amount of excess reserves is multiplied to give the maximum total change in money supply.
• For example, if the initial change in excess reserves is $900 and the final change in the money supply is $4500, the money multiplier has a value of 5: IN MONEY SUPPLY = IN EXCESS RESERVES x MONEY MULTIPLIER
$4500 = $900 x 5
The Money Multiplier
The multiplier is the reciprocal of the reserve ratio. If banks reserve 10% of deposits, the money multiplier is 10.
The initial change in excess reserves eventually causes an increase in the money supply
Money multiplier = 1
reserve ratio
10 = 1
.10
10% reserve rate causes an increase in the money supply of $10,000 ($1000 x 10); If the rate decreased to 5%, the money multiplier would be 20 (1/.05), causing an increase in the money supply of $20,000 ($1000 x 20).