This great introduces us to the duty of money in our economy, the American Banking mechanism (including the commonwealth Reserve system of the joined States), and the usage of financial policy come manipulate price levels and employment in the us economy.

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Section 01: The functions of Money

Money fulfills three primary features in ours economy: It is a tool of exchange, that is a measure up of value, and also it is a keep of value. Let’s consider each of these attributes in turn.

Medium of Exchange

Money is the means by which we acquisition goods and also services. If there were no money, we might suppose that we would certainly exchange goods and services straight for each other in a barter system. It does no take much creativity to see just how money is valuable to facilitate exchanges that would certainly be an overwhelming by barter. Imagine acquisition a pig into and shoe store and also trying to exchange it because that a pair the tennis shoes. This instance is fraught v all kinds of difficulties. What if the owner that the tennis shoes does not take place to desire a pig or any section of a pig? What about the reality that the pig might be worth 5 bag of tennis shoes and you just want one pair? Is the reasonable that the shoe keep owner have the right to accept only 1/5 that a pig for a pair of tennis shoes? exactly how would he have the ability to do this? Money facilitates the exchange, due to the fact that everyone is willing to expropriate money together a tool of exchange for whatever it is that one could want come buy or sell. It is also really easily divisible come the scale of what is being exchanged.

Measure of Value

Money is likewise a measure up of value and acts as a yardstick because that measuring the relative worth of heterogeneous goods. It might be daunting to recognize off the height of your head the a pig is worth ten bag of tennis shoes, yet money renders this basic to measure. If a grown pig have the right to be marketed for $300 and a pair of tennis shoes have the right to be marketed for $60, climate we deserve to say the a pig is precious 5 bag of tennis shoes. Money makes this calculation feasible because it is a measure of value. How much consistent gasoline could you trade for a pound of roast beef? The answer to the question can not be obvious to girlfriend at an initial blush. Let’s say the you were told, however, the sliced roast beef in ~ the Deli respond to at Broulim’s Grocery keep is $7.00 a pound and also that continual gasoline at the Maverick Gas station in Rexburg i would is $3.50 a gallon. Now girlfriend would know that you could get two gallons of regular gasoline for one lb of roast beef, and money as a measure of value offers you through the answer!

Store the Value

Money is a keep of value since it is a liquid (or spendable) resource of wealth. Some people select to host on to money together an asset, as with they can have a home, a painting, or a diamond ring. Money has actually an benefit over other assets due to the fact that it is very liquid. The liquidity of one asset refers to how easily the asset can be turned right into cash, and since money is currently cash, that is the most liquid heritage possible! This is most likely the factor that so many human being hold onto cash as a keep of value, as will certainly be seen when we talk about the contents of the money supply.

Section 02: The Money Supply

There space two widely used meanings of the money supply. One is a an ext narrow definition and the various other is a broader definition. We will look at both.


The first meaning of the money it is provided is referred to as M1. M1 consists of currency and also coins in the hand of the non-bank public, traveler’s checks, and checkable deposits. Currency and also coins constitutes about 50% the M1 and checkable deposits make up the various other 50%. Traveler’s checks comprise far much less than 1% the M1. As that April, 2011, M1 was $1,900,900,000,000, or almost two trillion united state dollars.


The second meaning of the money supply is called M2. M2 is a broader and less liquid definition of the money supply. While M1 constitutes money that is either cash or readily readjusted to cash, M2 includes much more types of money and specifically parts of the money supply that room harder come turn into cash. M2 consists of M1, savings Deposits, little Time shop ($100,000 or less), and also Money industry Mutual Funds. M1 makes up around 21% that M2, savings Deposits account for 61% the M2, little Time Deposits consist of 10% the M2, and also Money market Mutual accumulation constitute roughly 8% that M2. As that April 2011, M2 was 8,946,100,000,000 or almost nine trillion united state dollars.

Section 03: demand for Money

Given ours explanations the the features of money, it will not it is in surprising the there are two different species of demand for money. The very first is referred to as the transactions demand and the second is referred to as the asset demand.

Transactions Demand

On a daily basis human being need money on hand because that the points that they consistently buy. You have to gain a haircut or protect against by the save on the way home from work-related to choose up some milk. You have actually transactions that you must conduct, and also therefore you have actually a demand for money. The transactions demand for money is making use of money as a tool of exchange. Notice in the graph listed below that the Transactions need for Money (DMT) is denoted as a upright line once graphed versus the interest rate. The need for money as a medium of exchange is live independence of the interest rate, because when you space on your way home native work and also need to choose up milk, the interest rate does not impact how lot milk you buy.

Asset Demand

Some world hold money together a jae won asset similar to stocks and also bonds. Holding money together a fluid asset is making use of money together a store of value. Consider a human being who has actually a portfolio of investments. Perhaps the owns part stocks, bonds, jewelry, artwork, a home, a save account in ~ his credit transaction union, and also has $5,000 in a fireproof box hidden in his basement. In an emergency, the cash is the many liquid asset the the person has, and also is far an ext spendable 보다 a painting or a item of jewel that might take weeks to turn right into cash. The liquidity that cash is the benefit of hold cash. The disadvantage of holding money as an asset is that there is very tiny or no return on this asset.

The cost of holding money as an asset is the foregone attention rate and also there is an train station relationship between the attention rate and also the asset need for money. This inverse relationship is depicted in the graph below as a downward sloping asset need for money (DMA). The full demand that money (DM) is just the amount of the transactions demand and also the heritage demand, and has the very same downward slope as the heritage demand.


Section 04: The Money Market


We will certainly make a simplifying presumption that the it is provided of money is set by commonwealth Reserve policy, and also is as such shown graphically together a vertical line.

Adjustments to a decrease in the supply of Money — When the supply of money reduce (shifts come the left) the interest rate goes up.

Adjustments to rise in the supply of Money — as soon as the supply of money increases (shifts to the right) the interest price goes down.

Adjustments to a diminish in the demand for Money — When the demand for money to reduce (shifts come the left) the interest price falls.

Adjustments to an increase in the need for Money — as soon as the need for money boosts (shifts come the right) the interest price goes up.

The over four statements have the right to be easily depicted by shifts in the graph above, but can you watch the reasonable economic debate behind each? Let’s highlight with the an initial statement and then you work through the similar logic on the various other three.


What would take place if there to be a decrease in the supply of Money indigenous SM come SM’? If you stay at the old interest rate of i˳ once the supply of money falls, then the demand for money will exceed the supply of money. What would you do if girlfriend were running a financial institution and more people come in inquiry money than there were coming in and also supplying money? Wouldn’t your natural reaction be to boost the interest price in the hope that the greater interest rate would to decrease the need for money? Remember the at a greater interest rate, the asset need for money will be less. As the interest price goes up, the need for money and the it is provided of money will eventually come into equilibrium again at a higher interest rate, say i*. You can use similar logic to analyze each of the other three scenarios.

Return to the food in I-Learn and complete the activity that coincides with this material.

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Section 05: Why are there so numerous interest rates?

Our previous conversation referred come the interest rate as though there was just one in the economy. The truth is that there are numerous interest rates. The interest price on your credit card is various than the interest price for a vehicle loan, i m sorry is different than the rate you could be charged on a house loan. Let’s think about four determinants that will influence the attention in any given situation.