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Canada (510,314)
Economics (1,590)
ECO102H1 (155)

chapter 27

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Michael Ho

27.1 the nature of Money What is money Money is defined as any general accepted medium of exchange. Medium of exchange: anything that generally accepted in return for goods and services sold. Money also acts as store of value and as a unit of account. Money as a medium of exchange: Barter: a system in which goods a services are traded directly for other goods and services. The major difficulty with barter is that each transaction requires a double coincidence of wants meaning anyone who specialized in producing one commodity would have to spend a great deal of time searching for satisfactory transaction. The use of money as a medium of exchange solves this problem, as people can sell their output for money and then in separate transaction, use the money to buy what they want from others. The double coincidence of wants is unnecessary when a medium of exchange is used. Money greatly contributes to the efficiency of the economic system. To serve as an efficient medium of exchange it must carry some characteristics: 1. Easily recognizable and readily acceptable 2. Must be divisible because money that comes only in large domination is useless for transaction having only a small value. 3. Reasonably durable 4. It must be difficult but not impossible to counterfeit. Money as a store of value: Money is a convenient means of storing purchasing power; goods may be sold to date for money and the value may then be stored until it is needed for some future purchase. To be a satisfactory store of value, however, money must have a relatively stable value. When the price level in stable the purchasing power of a given some money is also a stable, when the price level is highly variable, so is the purchasing power of money, and the usefulness of money as a store of value is undermined. Money as a unit of the account: Money may also be used purely for accounting purposes without having to physical existence of its own The origins of money Metallic money: years ago, the market value of the metal was equal to the face value of the coin Greshams law: the theory that bad or debased, derives good, or undebased, money out of the circulation Debasing was that people would by coins and melt them and take little amount of real valuable metal and other unvaluable metal and mix them together to make coins and use them in the circulation of money in the economy as a result, the value of the real coin decreased and increased inflation and derived the real valuable coins out of the circulation, which lead to only paper money to be valuable. Greshams law predicts thats when two types of money are used side by side, the one with the greater intrinsic value will be driven out of circulation Paper money: Since carrying gold was risky people would leave their gold with goldsmith for secure safe and gold smith would give them a receipt so that they can claim their gold whenever they need to buy something. Later on buyer began to transfer to receipt to the seller as a medium of exchange which was backed up by the gold in the vault of the goldsmith. This receipt became the paper money represented a promise to pay so much gold on demand. In this case the promise was made first by goldsmith and later and by banks. Such paper money was backed by precious metal and was convertible on demand into this model. Bank notes: paper money ensured by commercial banks which was nominally convertible to gold. Each bank issued its own notes, and these notes were convertible into cooled at the issuing bank, therefore man to notes from many different bands circulated side by side, each of them being backed by gold at the bank that issued them. Fractionally backed paper money: Many goldsmiths and banks discovered that it was not necessary to keep 1 ounce of gold in the vaults for every claim to 1 ounce circulating as paper money. At that time some of the bands customer would be withdrawing gold, others would be depositing it, and most would be trading in the bands paper notes without any need or desire to convert that into gold. As a result Banks was able to issue more paper money redeemable in gold than the amount of old that each held in its vault, as a result the money could be invested profitably in interest earning loans to households and firms which was a good business for the banks, where banks claims outstanding against those household and firms than they actually have in reserve available to pay those claims, which is called the fractionally backed by the reserves. The major problem with the fractionally backed convertible currency was maintaining its convertibility into the precious metal behind it, becomes if the bank issued too much paper money and found itself unable to redeem its currency in gold when the demand for gold to rise even slightly higher than the usual, it too would then have to suspend payments and all holders of these notes would suddenly find that the notes to be worthless Fiat money: As time went on, currency issued by private banks became less common and central banks took control of issuing currency permitted by the law. Originally, the central banks issued currency that was fully convertible into gold, so gold would be brought to the central bank, which would issue currency in the form of gold certificate that, asserted that the gold was available on demand. The reserved gold thus set an upper limit on the amount of currency that could circulate in the economy. Gold standard: a currency standard where by a countrys currency is convertible into gold at a fixed rate of exchange. However, central banks, like private banks before them, could issue more currency than they had in gold because in normal times only a small fraction of the outstanding currency was presented for payment at any one time. Thus, even though the need to maintain convertibility int
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