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Unformatted text preview: Lecture 1 Foundations of Money Readings: Handa (2009)-Chapter 1 Bain and Howells (2009)-Chapter 1 Section 1.1 Defining the Concept of Money What is money? I Unit of Account : Money is one simpler way of measuring the value of goods and services. The use of money makes trade simpler, because we only need to know prices in terms of money, rather than relative prices of all goods. II Medium of Exchange : Money promotes economic efficiency by minimizing the time spend exchanging goods and services. This reduces the need for what Jevons called the Double Coincidence of Wants. The medium of exchange is very important to many theories in justifying the efficiency of monetary systems over barter systems. III Store of Value : Money can be used to store purchasing power from the time received until the time that it is spent. This allows for separation of the decision to buy from the decision to sell. This feature of money also reduces the need for the double coincidence of wants. IV Standard of Deferred Payments : Money can be used as a standard for the quantity of debt. Section 1.2 Do We Need Money? What is the current orthodoxy? And what are the alternatives? 1 Money reduces uncertainty. In a barter economy, decisions are made on incomplete information, whereas monetary economies allow for more efficient use of resources Money reduces transactions and information costs. It can be seen that money makes the economy more efficient since as a unit of account, money allows people to spend more time producing goods and services. The number of prices that need to be calculated in a multi-good economy is reduced exponentially. In an economy with J goods, if agents are bartering there are J 2- J prices assuming you dont want to trade one good for itself. However, if you are in a monetary economy, there are only J prices. If J = 10, the difference in prices is 90 versus 10. As J grows larger, the difference in the number of prices grows exponentially (Champ and Freeman, 2001, p. 36). Why did money develop as it did? Why does it have to change hands? Goodhart (1988) stresses the informational problem of trustworthiness and/or creditworthiness of the counter-party, leading money to change hands. The Cash-in-Advance constraint , or Liquidity Constraint means that credit is not acceptable for a trade to take place....
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This note was uploaded on 05/22/2011 for the course ECON 430 taught by Professor Neveu during the Spring '11 term at James Madison University.
- Spring '11