Chap4.10 - 1 Econ. 102. Chapter 4. Money, Inflation,...

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Econ. 102. Chapter 4. Money, Inflation, Interest Rate, Quantity Theory of Money 1. The cost of living is the number of dollars it takes to buy the goods and services that achieve a given standard of living. A rising cost of living, which is called inflation , means a shrinking value of the dollar. A falling cost of living, which is called deflation , means a rising value of the dollar. 2. Barter exchange is the direct exchange of goods or services for another. It needs to exchange goods and services directly for other goods and services and then requires a double coincidence of wants . The barter exchange is cumbersome and inconvenient and inhibited the specialization. 3. Monetary economy: An economy in which trade takes place through a generally accepted medium of exchange (money). By accepting money, people can specialize in producing a few goods and trade them for others; without money, we would waste much time constantly bartering one good for another. 4. Money : Any commodity or token that is generally accepted as a means of payment . 5. Means of payment: A means of payment is a method of settling a debt . 6. Three functions of money: (1) Medium of exchange : An object that is generally accepted in return for goods and services. (2) Unit of account : An agreed-upon measure for stating the prices of goods and services. (3) Store of value : Money can be held and exchanged later for goods and services. 7. Money today in the world is called fiat money (i.e., objects that are money because the law decrees or orders them to be money). The objects that we use as money are (1) currency, and (2) deposits. a. Currency : the bills and coins. Bills are money because the government declares them so with the words that “ This note is legal tender for all debts, public and private .” b. Deposits : Deposits at banks and other financial institutions such as savings and loan associations (S&L). Deposits are money because they can be converted into currency and used to settle debts. Example: In modern economy, money supply (M s ) = currency + deposits at banks and other financial institutions. We have M1 and M2 in 6/30/2003 as M1 1,368.4 100% Currency and traveler’s check 716.0 52.3% Checkable deposits 652.4 47.7% M2 6,509.7 100% Currency and traveler’s check 716.0 11.0% Checkable deposits 652.4 10.0% Saving deposits 3,545.8 54.5% Time deposits 898.8 13.8% Money market funds 696.7 10.7% This shows that most money is bank deposits, not currency. It should be noted that banks create deposits, and they do so by making loan . But they can not create any amount of money they wish. The amount of deposits they can create is limited by their reserves . 1
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8. How banks create money ? Banks create money by making loans and creating deposits . The amount of deposits they can create is limited by their reserves and rr. Example:
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This note was uploaded on 09/08/2010 for the course ECON 102 at San Jose State University .

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Chap4.10 - 1 Econ. 102. Chapter 4. Money, Inflation,...

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