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Unformatted text preview: ECON 0110: Introduction to Macroeconomics Lecture Notes for Topic 9: The Money Supply and the Federal Reserve System James R. Maloy, Department of Economics, Spring 2008 Readings: Case & Fair, Chapter 10 1 What is Money? The term “money” is often mis-used in everyday usage; from an economics standpoint, money is defined as anything that performs the functions of money (which will be discussed below). Many things are denominated in money but are not actually money in themselves; income is not the same thing as money, nor is wealth. Wealth is a person’s total stock of assets. Although money can be one such asset, other assets include houses, cars, bonds, paintings, etc. Therefore, although your wealth or income are often expressed in monetary terms such as “he is worth $10m,” they are NOT the same thing. Likewise, a firm’s costs of production ($50 for raw materials, for example) are expressed in terms of their monetary value but are also not the same as money. Furthermore, prices are expressed in terms of money, but they are not the same thing. Also, money does not have to be bits of government-issued paper or coins; historically, many other items have fulfilled the functions of money such as gold, chariot wheels, seashells, etc. The salient element for any commodity to be considered money is not that the commodity itself must be intrinsically valuable (although in past times when gold was money, the value of money 1 was indeed the value of gold), but rather that the commodity has to be generally accepted as money. Federal Reserve notes are intrinsically useless, but you can buy useful goods and services with paper money because they are generally accepted as money. (As a side note, if people in a nation lose faith in the value of the government-backed paper currency, then the monetary system runs into severe difficulties. This typically happens during hyperinflations when paper money becomes increasingly worthless.) 1.1 The Functions of Money 1.1.1 Transactions Money is any item that is generally accepted as a means of payment for goods of services (typically referred to as a medium of exchange ). This has historically been considered the most important use of money (until Keynes added some other functions in his General Theory in 1936). The Classical economists saw transactions as the primary reason for holding money. The classical view of money can best be summed up by the words of John Stuart Mill: There cannot be intrinsically a more insignificant thing, in the economy of a society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it; and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order....
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This note was uploaded on 03/10/2012 for the course ECON 1110 taught by Professor Tedloch-temzelides during the Spring '08 term at Pittsburgh.
- Spring '08