Chapter 10.pdf - Money Banking Interest Rates and Monetary...

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Chapter 10. Money, Banking, Interest Rates and Monetary Policy WHAT IS MONEY? Money is defined as (and thus amounts to) anything that is generally accepted as a medium of exchange . This is the necessary and sufficient condition for something to qualify as money: it must be generally accepted in the process of exchange. Neither the actual form of money nor any other functions that it may perform matter in this context; as long as an economic object is generally accepted as the medium of exchange, then it is money. The first important function of money directly follows from this definition, namely, its function as a medium of exchange . Money may be seen as anything that is used to pay for a product or settle a debt. Money is therefore essentially what the public is willing to accept as a means of payment (or medium of exchange). In the past, various commodities have been used as money, for example seashells, salt, buttons, sharks’ teeth, beads and, of course, precious stones and gold. During and after a major war, cigarettes have often been used as money, especially in prisoner-of-war camps. The Properties of Money It therefore follows that to qualify as money, an object must meet certain social demands, that is, have certain properties. When money still had a tangible form, it was expected to have the following properties. Page 220 General acceptability The medium of exchange (means of payment) must be acceptable to everyone who buys and sells, borrows and lends in the economy. The wish to obtain, possess and spend money must be generally present among the population. Precious metals like gold and silver were particularly well suited to international transactions. Durability The medium of exchange constantly passes from one person to another; it is therefore handled a great deal. The means of payment should therefore be durable and not lose value by wastage or attrition. Metal alloys were durable and could be easily manufactured. Portability The mass of the medium of exchange should be low in relation to its value. This property would mean that large sums of money could be readily transported without excessive cost. It should also be easy to handle, that is, not be excessively heavy or bulky. Homogeneity and divisibility Money of a given value (denomination) should be made of the same material, in order to avoid confusion. It should also be divisible into lesser units (e.g. coins, small change). This is necessary mainly because the prices and value of goods may vary a great deal.
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Recognizable The requirement that money should be easily recognizable is closely related to the property of homogeneity above. Stable value Seeing that the medium of exchange also functions as the measure value (discussed below), it should not fluctuate in value. Just as the measures of length, mass and volume do not change, so should the value of money, too, be stable. A medium of exchange that changes a great deal in value would not be trusted (generally accepted) by society.
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