Chapter 7 The Asset Market, Money, and PricesLearning Objectives I. Goals of Chapter 7 A) What money is and why people hold it B) The decision about money demand is part of a broader portfolio decision C) Equilibrium in the asset market occurs when money supply equals money demand D) The price level is related to the level of the money supply II. Notes to Fourth Edition Users A) The application, “Financial Regulation, Innovation, and the Instability of Money Demand” has been modified and now includes a time-series plot of the growth rates of M1 and M2 Teaching NotesI. What Is Money? (Sec. 7.1) A) The functions of money 1. Medium of exchange a. Barter is inefficient—it requires a double coincidence of wants b. Money allows people to trade their labor for money, then use the money to buy goods and services in separate transactions c. Money thus permits people to trade with less cost in time and effort d. Money also allows specialization, since trading is much easier, so people don’t have to produce their own food, clothing, and shelter Theoretical Application There have been a number of attempts to supply detailed microfoundations theory for money. Recently, an explicit theory that shows the superiority of money to barter has been developed by Nobuhiro Kiyotaki and Randall Wright (“On Money as a Medium of Exchange,” Journal of Political Economy, August 1989, pp. 927–954). They show how introducing fiat money unambiguously improves society’s welfare. Much recent research builds on this type of money model. 2. Unit of account a. Money is the basic unit for measuring economic value b. This simplifies comparisons of prices, wages, and incomes c. The unit-of-account function is closely linked with the medium-of-exchange function d. But countries with very high inflation may use a different unit of account, so they don’t have to constantly change prices
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