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For example lets assume we have an economy without

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goods in the economy increases. For example, let’s assume we have an economy without money. We’ll take each case in turn: 1. Suppose that there is an economy with only one good, apples. Then prices are impossible, since there is no other good to be used for measurement. There’s nothing to compare the apples to. 2. With two goods, apples and bananas, there is only one relative price, the price of apples compared to the price of bananas, or P A /P B . Once we know P A /P B , we also know P B /P A . 3. Suppose there are three goods, apples, bananas and cherries. Then we have three relative prices to consider: P A /P B P B /P C P A /P C 4. With four goods, apples, bananas, cherries and dates, we have six possible sets of relative prices: P A /P B P B /P C P C /P D P A /P C P B /P D P A /P D 5. With five goods, apples, bananas, cherries, dates, and eggs, the number of relative prices is now ten: P A /P B P B /P C P C /P D P D /P E P A /P C P B /P D P C /P E P A /P D P B /P E P A /P E Do you notice a pattern here? As the number of goods increases, the number of relatives prices increases exponentially. The formula is actually: # relative prices = [N(N – 1)]/2 27
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Econ 350 U.S. Financial Systems, Markets and Institutions Class 4 So the existence of money makes it much easier to think! Rather than having to carry around thousands of sets of relative prices in our heads, we only need to know the price of each good and then we can compare from there. We are able to have room in our brains for much more important things, like taking this course! Store of value Since money is durable, it acts as a store of value. By doing so, it allows the accumulation of wealth to take place. It is much easier to store money than it is to store goods or services. For example, suppose that I am a fisherman and that my daughter is getting married. I want to save up so that my daughter can have the wedding of her dreams. Also assume that no money exists. In order to save for my daughter’s wedding, I take my boat out an hour early each day and stay for an hour later each night, and catch lots of extra fish which I then throw in a barrel in the basement. I diligently do this until my daughter’s wedding day. Will my daughter have a nice wedding? Of course not! All we’ll have is a pile of smelly fish in the basement. But, if I can take my fish to the market each night and sell them for money, and then throw the money in a barrel in the basement, then I can save up and my daughter will have a wonderful wedding. Money allows me to accumulate wealth in a way that fish cannot. While some types of commodity money such as maize and tobacco leaves may not have been very durable, the more durable a commodity is, then the more easily it could be used as money. Standard of deferred payment Money also allows debts to be expressed and paid back with items similar in quality to what was borrowed. Money is fungible, or substitutable or replaceable. If I lend you a nice, crisp, brand new dollar bill, it doesn’t matter if I get paid back with the same dollar bill, an old crumply dollar bill, two half dollars, or four quarters.
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