Macroeconomics plus MyEconLab plus eBook 1-semester Student Access Kit (6th Edition)

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Chapter 7 The Asset Market, Money, and Prices Learning 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 Fifth Edition Users A) The Fed has discontinued the M3 monetary aggregate, so material related to it has been deleted from the textbook B) A new section on “time to maturity” has been added to section 7.2 on portfolio allocation and the demand for assets C) A new application on measuring inflation expectations has been added Teaching Notes I. What Is Money? (Sec. 7.1) A) Money: assets that are widely used and accepted as payment B) 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.
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Chapter 7 The Asset Market, Money, and Prices 139 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 3. Store of value a. Money can be used to hold wealth b. Most people use money only as a store of value for a short period and for small amounts, because it earns less interest than money in the bank Theoretical Application Money’s usefulness as a store of value declines the higher the inflation rate. In hyperinflations (very high inflations), people try to avoid the use of money; on receiving their wages, they rush to buy things before prices rise. And they tend to use currencies other than their own, a phenomenon known as currency substitution. 4. Box 7.1: money in a prisoner-of-war camp a. Radford article on the use of cigarettes as money b. Cigarette use as money developed because barter was inefficient c. Even nonsmokers used cigarettes as money d. Characteristics of cigarettes as money: standardized (so value was easy to ascertain), low in value (so “change” could be made), portable, fairly sturdy e. Problem with having commodity money like cigarettes: can’t smoke them and use them
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