Chapter 12 - Money and the Banking System
We will now switch from fiscal policy to monetary policy in the next two chapters.
We first look at Money and the Banking System and then focus on monetary policy in
the next chapter.
WHAT IS MONEY?
Unlike gold or silver, modern money has no intrinsic value - green paper - but
everyone wants more of it. Why? Because of what it will buy.
Money is an asset that performs three functions:
1. Medium of exchange -
used as a means of final payment. We use dollars to pay for
goods and services. Increases efficiency of trade and exchange. Without money, we
would have a barter economy, trade goods for goods, or services for goods, etc. Barter
is inefficient because it relies on the "double coincidence of wants."
For example, to get food, you would have to find a farmer who has what you want and
you would have to have exactly what he/she wants. To get medical service, the farmer
would have to find a doctor who wants a cow or milk, etc.
Barter is extremely inefficient. Compared to barter, money is extremely efficient. The
farmer can sell a cow for money, and then go out and buy whatever he/she wants with
the cash - medical services, electricity, etc. Money eliminates the "double coincidence
When is barter efficient? - baseball card convention, coin/stamp trading, etc. Market
for dating/sex/marriage. Russia - Pepsi/Stolys. To avoid high taxes. Or during
. Money is used as a unit of account.
In the US, everything is priced in dollars, so
we have a unit of measurement. Money is a measuring rod of value. By having a
common unit of account, unit of measurement, we can compare prices/values easily.
Everything is priced in a common unit of measurement, US dollars.
A barter economy is inefficient because there is no standard unit of measurement.
Makes comparison shopping very difficult. Thousands of terms of trade or trading
ratios. 5 goods - A, B, C, D and E. In a barter economy, there are ten trading ratios.