1294410387637_Chapte - CHAPTER 2 MONEY AND THE PAYMENTS SYSTEM A THE BASICS The primary focus in this chapter is on Core Principle 3 how we use

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______________________________________________________________________________________ 19 CHAPTER 2: MONEY AND THE PAYMENTS SYSTEM A. T HE B ASICS The primary focus in this chapter is on Core Principle 3: how we use information in the process of buying goods and services. This focus naturally revolves around the payments system and where money fits in to the overall process. Other core principles make appearances as well, as will be noted as we go along. This chapter is organized around three topics. First you will learn a conceptual definition of money, including how and why money has evolved from precious metals to paper backed by precious metals, to fiat money and now to electronic money. Second, you will learn about the evolution of the payments system and the role of money in this system. And third, you will learn the practical definitions (yes, plural) of money used by the Federal Reserve System (the “Fed”). These definitions evolve as the assets we use for money change; see chapter 20’s Applying the Concept : Financial Innovation and the Shifting Velocity of Money on text page 534 for a recent example of changes in the practical definitions of money. B. S OLIDIFY Y OUR K NOWLEDGE DISCUSSION/EXTENSIONS OF THE BASICS As was mentioned briefly in chapter 1, and will be discussed in much more detail in chapter 11, some transactions require expensive collection of information for one or both parties. If you apply for a loan, the lender must verify your employment, look at your tax returns, and ask for credit references to verify that you pay your other bills on time. You, in turn, provide copies of your tax returns, pay stubs from your employer, information on current loans as well as loans you’ve already paid off, etc. Other transactions are less expensive in terms of information costs. For example, most merchants do not accept a check without asking for identification, such as a home phone number and a picture ID. Even then, the merchant does not know if the customer has funds in the checking account (that’s risk, as in Core Principle 2). In contrast, paying with a credit card, where payment is made by the card issuer directly to the merchant, lowers the amount of information the merchant needs and lowers the merchant’s risk as well. On the other hand, want to buy a cup of coffee? Just take a dollar from your pocket, head to the student union on campus, and hand it to the cashier. There is no need for the seller to evaluate the creditworthiness of the buyer. Eliminating the need to spend time and resources on this evaluation allows more efficient use of both. The nice thing about your dollar is that it eliminates the need for the collection of information. Your dollar serves as money, an asset that is generally accepted as a means of payment (the basic definition of “money” introduced in this chapter).
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Chapter 2: Money and the Payments System ______________________________________________________________________________________ 20
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This note was uploaded on 09/07/2011 for the course ECO 412 taught by Professor Staff during the Spring '05 term at Kentucky.

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1294410387637_Chapte - CHAPTER 2 MONEY AND THE PAYMENTS SYSTEM A THE BASICS The primary focus in this chapter is on Core Principle 3 how we use

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