ppt for teachingmoney

8/7/2019 PPT for TeachingMoney

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Money: Functions of Money

The Four Jobs of Money

Medium of exchange Standard of value/Unit of account

Store of value

Standard of deferredpayment


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Medium of exchange

The most important job of money is to serve

as a medium of exchange

When any good or service is purchased, people

use money

Money makes it easier to buy and sell because

money is universally accepted

Money, then, provides us with a shortcut in

doing business

By acting as a medium of exchange, money

performs its most important function


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Money versus Barter

Without money, the only way to do

business is by bartering

For barter to work, I must want what you

have and you must want what I have This makes it pretty difficult to do business

Everything, then, must be assessed in

money: for this enables men always to

exchange their services, and so makes society possible Aristotle, Nicomachean Ethics


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Shows no

coincidence

of needs andno barter is

going on


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Money as a Medium of

Exchange

Money facilitates exchange byreducing

the cost of trading.

Without money, we would have tobarter.


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Money As a Medium of

Exchange

Money does not have to have anyinherent value/usefulness to function asa medium of exchange.

All that is necessary is that everyone

believes that other people willexchange it for other goods/services


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Standard of Value

Money is a common denominator

in which the relative value of

goods and services can be

expressed

A job that pays Rs 2 an hour would be

nearly impossible to fill, while one paying

RS 50 an hour would be swamped with

applications


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Money as a Unit ofAccount

Money is used as a common denominator to

measure the relative values of goods and

services. Without money, we would have to measure

the value of goods and services in terms of

other goods and services.

Money is a useful unit of account only if its

value relative to the average of all other

prices doesnt change too quickly.


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Store of Value

If you could buy 100 units of goods and services with $100 in 1982, how many

units could you buy with $100 in 2000?

Answer: you could have bought just 51 units

During this period, inflation robbed the dollar of almost half of its purchasing power

Over the long run, particularly since World

War II, money has been a very poor store

of value However, over relatively short periods of time,

say, a few weeks or months, money does not

lose much of its value


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Money as a Store of Value

Money is a financial asset that can be

used to store wealth (income that you

have saved and not consumed). As a store of wealth, money pays no

interest, but is perfectly liquid.

Moneys usefulness as a store of

wealth depends on how will it maintains

its value.


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Standard ofDeferred Payment

Many contracts promise to pay fixed

sums of money well into the future A couple of examples are 30-year

corporate bonds and a 20-year

mortgage


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Standard ofDeferred

Payment

How well does money do its job as a

standard of deferred payment? About as well as it does as a store of

value

Usually quite well in the short run, but

not well at all over the long run of, say,

three years or more


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Money - Prices and Interest rate

Classical Economists such as Irving Fisher holds that thereis proportional relation between Money supply and thePrice level

This is explained on the basis of the following

assumptions Economy is always at the full employment and Aggr.

Output is fixed at full employment level of output

Velocity of circulation of money is fixed as this isdetermined on the basis of payment habits, liquidity

preference, propensity to consume and development ofthe banking and credit institutions which do changeslowly


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Classical theory express this relation in the

following identity

MV= PT

V= PT/M P=MV/T

Modern Quantity theoryStates that growth of

money supply determines the nominal GDPand hence the nominal aggr. Demand throughwhich prices are influenced


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Hence targeting Money supply is essential In

the Economy. Here monetary policy is

important to regulate the economy.


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Keynesian liquidity preference theory

of money

Keynesian theory does not believe that the

economy remains always at full employment

level. There could be involuntary

unemployment in the economy due to lack of

aggr. demand.

Use diagram to explain


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Equilibrium aggr. Output with

unemployment in the economy

YfYE

AS

Price

level


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Keynesian economy also does not believe thatvelocity of circulation of money is constant

Hence Keynesian economy challenges thedirect and proportional relationship between

money supply and the price level. It shows that increase in money supply and

hence aggregate nominal demand may notalways increase price level :

When the economy is operating atunemployment equilibrium.


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Money market: Keynesian demand for

money

According to Keynes Money is demanded by

public for three motives:

1. Transaction 2.Precautionary motives

3.Speculative motives

Both Transaction and precautionary demandsfor money are depended on the level of

income and it is positively related


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Speculative demand for money is moneydemand as an asset

There are other financial assets: Bonds,debenture, Govt. Securities, Corporate

securities, Stocks etc. Difference between Money and other

financial assets

Money: most liquid

Holding money is riskless

But money is non income earning asset


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Other financial assets have less liquidity butthey yield income

Speculators wants money to buy other non

money financial assets at a low price and sell

them at a higher price and the difference

between buying and selling prices are their

incomes from trading financial assets.

Bond price i.e. price of fin asset is inverserelated to the interest rate.


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let the market rate of interest is 5%

If you hold cash of Rs. 95 for a year, you foregointerest income at the rate of 5%.

If you invest on a bond then you get Rs. 95(1+.o5)=99.75

Hence Pv.of Bond= Rs.100/1+0.05= Rs. 95 presentvalue of bond

1+0.05=95/100=.951+r= .95

r =1- .95=.05


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When interest rate is 10%

Present value of bond yielding Rs 100 is

PV= 100/1+10%

=100/1.1=90

Bond price is nothing but the present value ofbond at a given rate of interest.

Let Bv is the future yield from the bond then

Bp= Bv/1+r


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thus demand for real balance or liquidity

( L) has two components

Lt= transaction and precautionary demandwhich depend income and positively related.

Ls= which depends on interest rate and

inversely related


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Liquidity preference: Keynesian theory

of Money

r

M/PM//P

MS/p

L1= Md/p

L2=Md+change

in Md/pr1

r0

Ld Ls


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L(r) = M/P

Money DemandMoney DemandRealMoney BalancesRealMoney BalancesEquals

Money Market equilibrium


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r

M/P

L(r,Y)

r

Y

LM

M/P

Supply

Acontraction in the money supply raises the interest rate that equilibrates

the money market. Why? Because a higher interest rate is needed to

convince people to hold a smaller quantity of real balances.

As a result of the decrease in the money supply, LMshifts upward.

r1 r1

M/P

Supply'

L

r2 r2


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Component of Money stock

Year M0 M1 M32006-07 595227 851753 2763516

2007-08 730422 932875 3306510

2008-09 888314 1109240 4037610

2009-10 960390 1255771 4901751

Component of Money stock


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Defining various components of

Money

There are four measures of Money

M0= Base money = Currency in circulation

M1 = Mo + demand deposits with thecommercial banks + other deposits with RBI

M2= M1 + short term post office deposits

M3= M1 = Time deposits with the banks

M4= M3+ total post office deposits

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