money - 1 Asset Markets, Money, Prices and Interest Rate...

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Unformatted text preview: 1 Asset Markets, Money, Prices and Interest Rate Econ 302 Juan C. Cordoba Interest Rates Asset Markets y How is the interest rate determined? y The interest rate is an important determinant of the aggregate demand (consumption and investment) y The interest rate is likely determined in Asset Markets y Asset markets: Entire set of markets in which people buy and sell real and financial assets (gold, houses, stocks, bonds, buildings, money). y Money (liquid assets widely accepted to make purchases such as cash or checks) is a key asset in macro or checks) is a key asset in macro: y Legal tender y Unit of account: Prices are quoted in units of money (dollars) y Prices and inflation depend on the amount of money in the economy y Real activity may also depend on the amount of money. 2 What is money? Money = liquid assets (assets that are widely used and accepted as payment) . y Commodity money (intrinsic value): y gold, silver, copper, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, candy, barley etc. y Fi t ( i t i i l y Fiat money (no intrinsic value) y Coins and currency (typical) y Checks (check deposits) y Money Wealth or income Functions of money 1. Medium of exchange y Barter is inefficientit requires a double coincidence of wants y Money permits people to trade with less cost in time and effort y Money also allows specialization, since trading is much easier. 2. Unit of account y Money is the basic unit for measuring economic value y This simplifies comparisons of prices, wages, and incomes y Countries with very high inflation may switch to a different unit of account. 3. Store of value y Money can be used to hold wealth y Most people use money only as a store of value for a short period y .. but countries hold large amounts of dollars y .. Individuals use money to hide their wealth. 4. Legal tender y By law, money is needed to pay taxes and debts. 3 What is money? Money in practice is difficult to identify. A narrow definition is M 1 which includes currency, checkable deposits, travelers checks. Other more wider definitions are M 2 and M 3 which include less liquid financial assets that could be used for transactions although at certain cost. We now study the demand and supply of money. We will see that equilibrium in the money market implies equilibrium in all assets markets. U.S. Monetary Aggregates (May 2006) 4 The Money Demand: A model of optimal cash management....
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money - 1 Asset Markets, Money, Prices and Interest Rate...

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