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6. the asset market, money and prices

6. the asset market, money and prices - The Asset Market...

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The Asset Market, Money, and Prices 5 October 2010 1 Reading Chapter 7 of Abel/Bernanke/Croushore 2 Money as the Medium of Exchange Money in macroeconomics refers to commodities that serve as the medium of exchange , the need for which arises from the absence of the double coincidence of wants. Imagine 3 households: Households A produces good A but demands good B ; household B produces good B but demands good C ; household C produces good C but demands good A . There can be no mutually bene fi cial bi—lateral exchange between any two households. Yet collectively there are certainly gains to exchanges. In this environment, trade may be facilitated by a designated medium of exchange —money. Without a medium of exchange, people would have to barter — trading one com- modity one produces for another commodity that one desires for consumption. Clearly, barter is ine cient where the double coincidence of wants can be a rare event. With a medium of exchange in place, people can trade their labor for money, then use the money to buy goods and services in separate transactions. Money thus permits people to trade with less cost in time and e ff ort and allows specialization. Because money is the medium of exchange, it is natural to express the prices of goods and services in units of money. A secondary function of money then is that it serves as the unit of account . But in countries with very high in fl ation, so that the value of money changes very quickly, the use of money as a unit of account is ine cient because its use entails the need to change prices frequently. A di ff erent unit of account, such as in terms of a foreign currency, was sometime adopted. 1
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Historically, goods that possessed intrinsic values, such as gold, silver, and other precious medals, were used as the media of exchange. These are known as commodity monies . The principal problem with commodity money is that the quantity available is often at the mercy of the fl uctuations in the supply of the commodity. In modern times, almost any economies have chosen to adopt paper currencies and coins issued by the public sector as money. Such forms of money is known as fi at money —a commodity that has no intrinsic value but is valuable only because it has become a commonly acceptable form of payment for goods and services. Households and businesses are willing to hold a fraction of their wealth in money, as opposed to other assets, because of the convenience that money is a commonly acceptable form of payment. Thus money can also serve as a store of value . There must be a lower rate of return on money holding than the rate of return on holding other assets in equilibrium for people to choose to hold these other assets if money is the unique asset that is commonly accepted as means of payment. In fact because of the di culty of paying interest on hand—to—hand currency, the interest rate on currency is typically zero.
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6. the asset market, money and prices - The Asset Market...

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