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1BB3 Notes chapter 10.docx

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McMaster University
Bridget O' Shaughnessy

Lecture # Chapter 10 Macroeconomics 1BB3 Date: 24/10/2012 The Monetary System Money • An asset that is regularly used to buy goods and services • Money has 3 functions o Medium of Exchange, use it to buy goods and services o Unit of account, most prices in the economy are measured by money(Canadian dollars) o Store of value (asset) • Credit Card is not a medium of exchange; it is a method of deferring payment. Liquidity • The ease with which an asset can be converted into the economy’s medium of exchange (money) • When prices of rise, the value of money falls. Commodity Vs. Fiat money • Commodity money: Money that takes the form of commodity with intrinsic value. • Intrinsic value refers to that the item has value even if not used as money. • Fiat money: Established as money by government decree, with no intrinsic value. • Fiat money has value not because it is stamped by the government, but because people accept it as a medium of exchange. In other words, people think it has value. Money in the Canadian Economy M = C + D • C = Currency: Paper bills and coins in the hands of the public. (circulating, not in the bank vault) • D = Demand Deposit: Checking account. The balances in bank account that depositors can access on demand by using a cheque or using a debit card • Canadian currency is about 46 billion dollars and demand deposit is in the form of demand deposit. • Average currency holding for Canadians is $1800 per adult. • Canadian Dollars are not backed by a gold standard. Fractional Reserve Banking • Abanking system in which the bank holds only a fraction of the depositors’money as reserves. • Reserve ratio is the fraction of the total deposits that a bank holds as reserves. Money Creation using T-Accounts • Assets must EQUAL to liabilities • For Banks, Reserves and loans assets and Deposits are liabilities Money Multiplier • The amount of deposits the whole banking system generates with each dollar of reserves o Money Multiplier = 1/Reserve ratio Bank of Canada Canada’s central bank established in 1935 • The Bank of England is the oldest bank which still exists. • The Bank of Canada has four main
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