CHAPTER 1: AN INTRODUCTION TO MONEY AND THE
In reading Chapter 1, taking time to think about the ideas presented will pay
dividends throughout the remainder of the term. In particular, the Five Core Principles
presented in this chapter hold the key to your success in this course. But even more
importantly, these five principles almost surely hold the key to your financial success in
life. Why? Because while you could learn “facts” about the current structure of the
financial system and how this structure affects you, by the time you might be able to
apply these facts (say in five or ten years, when you will have achieved a good measure
of success) they may no longer describe the financial system. After all, markets evolve
and what is true at one time may well be irrelevant later. By learning basic principles and
understanding how they help you understand evolving markets, you will be much better
positioned to continue to capitalize on your initial successes. At every step of the text,
you will use one or more of these principles to gain insights into how modern financial
systems are organized, how they have evolved to their current states, and how to
understand subsequent changes.
This chapter has two major topics as well as an important appendix. First, a
financial system has six key parts. They are: money, financial instruments, financial
markets, financial institutions, regulatory agencies, and a central bank.
Second, the financial system and how it interacts with the rest of the economy is
learned most easily by understanding and applying Five Core Principles: (1) Time has
value; (2) Risk is not undertaken without compensation; (3) Information
is the basis for
making decisions; (4) Markets efficiently allocate resources by determining prices; and
(5) Stability enhances our welfare or well-being.
Finally, the chapter appendix presents a definition of gross domestic product
(GDP), including the distinction between “nominal” and “real” GDP.
DISCUSSION/EXTENSIONS OF THE BASICS
Let’s think in detail first about the key elements of the financial system. These are
listed below, along with a brief discussion of each.
is an asset widely used for buying things (a “means of payment”). Money
being an asset means that it acts as a store of value. Bury it in a can in the back yard
today, dig it up a couple of years later, and it will still be accepted for payments – it has
retained value. Being widely acceptable means money is used throughout the economy.
Young children might be able to use baseball cards when buying Xbox games from their
friends, but most participants in the economy will not accept the cards as payments.