Unit 4- Money

Functions of Money

1. Medium of Exchange
• Serves to trade one product to another
2. Store of Value
• Where money holds it's value over a period
3. Unit of Account
• Establishes economic worth

Types of Money

1. Commodity Money
• It gets its value from the type of material from which it's made
• Example: Gold, silver
2. Representative Money
• Paper money backed by something tangible that gives its value.
• Example: Gold-or-silver-backed money and IOUs
3. Fiat Money
• Money because the government says so

Characteristics of Money

1. Durability
2. Portability
3. Divisibility
4. Uniformity
5. Scarcity
6. Acceptability
7. Limited supply

Money Supply

1. M1 Money

• Consists of currency in circulation, which can be:
• Currency (cash and coins)
• Checkable deposits aka demand deposits and checking accounts
• Traveler's checks

Liquidity: easy to convert to cash

      2. M2 Money

• Consists of M1 money + savings accounts + money market accounts
• Savings accounts: a bank account where you can store money you don't need right away but still keep it easily accessible
• Money market accounts: savings account with some checking features; they typically come with checks or a debit card and allow a limited number of transactions each month; traditionally, they've also offered higher interest rates than regular savings accounts

      3. M3 Money

• Consists of M2 money + Certificates of deposit

Time Value of Money

• v = future value of $
• p = present value of $
• r = real interest rate (nominal rate - inflation rate) expressed as a decimal
• n = years
• k = number of times interest is credited per year

The Simple Interest Formula: v = (1+r)^n * p
xπxπ * p

The Compound Interest Formula: v = (1+r/k)^nk * p

Balance/Business Sheet

-Summarizes the financial position of a bank at a certain time

-The value of assets must equal the value of claims
-Claims on a balance sheet are divided into two groups

Assets (Credit)

• Required Reserves (RR)
• Excess Reserves (ER)
• Loans
• Property
• Bonds (Government securities)

Liabilities (Debt)

• Demand Deposits
• Owner's Equity
• Net worth

Owner's Equity: Based on how much you invested into stock

Net Worth: What you've earned

The Federal Reserve

Fractional Reserve Banking System

• The banks have to hold a fraction of the total money supply as currency

Money Creation

Putting new money into circulation using two methods

1. When the federal reserve bank buys bonds from people or financial institutions (OMO or open market operations)
2. When banks make loans to the public

• The money supply is increased when banks make loans.
• The more loans banks make, the more money there is in circulation.
• A bank can loan any amount that is in excess of its required reserves.
• The banking system can create loans in multiples of an original loan

• Reserves or total reserves
• The amount of deposits that a bank has accepted but not loaned out.
• Required Reserves
• The amount a bank must keep on hand by law
• Excess Reserves
• Whatever the bank has over and above the required reserves
• The required reserve ratio determines this amount

Functions of the FED

• It issues paper currency
• Sets RR and holds reserves of banks
• It lends money to banks and charges them interest
• They are a check clearing service for banks
• It acts as personal bank for the government
• Supervises member banks
• Controls the money supply in the economy

Types of Multiple Deposit Expansion Question

• Type 1: Calculate the initial change in ER
• aka. the amount a single bank can loan from the initial deposit
• Type 2: Calculate the change in loans in the banking system
• Type 3: Calculate the change in the money supply
• Sometimes type 2 and type 3 will have the same result (i.e. no Fed involvement)
• Type 4: Calculate the change in DD