C48 MT 10F A.doc

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Department
Economics for Management Studies
Course
MGEC71H3
Professor
Melanie Parkin
Semester
Fall

Description
UTSCECM C48 MidtermFALL 2010 SolutionsQuestion 120 MarksSOLUTIONA6 marks2 marks each1 Medium of Exchange means of exchangeWithout money we would have to exchange goods and services directly through what is known as barter Money simplifies these exchanges2 Unit of Account unit of measurementAs a unit of measurement money allows us to compare the value of goods and services It is both the standard for pricing goods and services and the means of buying and selling them Money also allows us to compare costs income and profit across time As such money is the foundation of the accounting system which allows us to plan and make economic decisions3 Store of Value means of storing purchasing power for future useAs a reserve money allows us to accumulate savings over time and to lend those savings to someone else It makes it much simpler for us to make contracts via promising to do something now for payment in the futureB4 marksChequean instrument to transfer money from one account to another between banksCheques allow transactions to take place without the need to carry around large amounts of currency which is a major innovation that improved the efficiency reduced transportation costs of the payments system when payments made back and forth cancel each other 2 marksProsCheques can be written for any amount up to the balance in the account or even over it with overdraft feature making transactions for large amounts much easier and greatly reduce the loss from theft and provide convenient receipts for purchases 1 markConsProblems with a payments system based on cheques i takes time to get cheques from one place to another and may take several business days before a bank will let the account holder to use the fund from a cheque deposited and ii all the paper shuffling required to process cheques is costly 1 mark2C5 marksGreshams Law says the bad money drives out the good money What is meant by this is that the bad money literally causes the good money to no longer circulate or be accepted This theory can be applied to things more widely than just money or economics and financesuch as movies parties clothing etcExamples include1 In a commodity money system based on gold or silverpeople shaving small amounts of valuable gold or silver off from coins before tendering them as a means of payment this caused governments and people to institute minimum acceptable weights for coins to be acceptable as payment for certain face valuesas a way to stop or limit this practicebut this raises transactions costs of using such coinagethe bad money the low weight coinage drives the good money gold or silver coins out of use due to these possible ripoffs2 In a bimetallic commodity money system based on gold AND silver coinageif the relative price of one of the metals were to suddenly change the government would have an incentive to buy enough of the relatively cheaper metal mint up coins and use them to buy back all of the coinage in the other relatively more expensive metal and melt them down and sell this metal at a profit the bad money the cheaper metallic coins drive the good money the coins made out of the relatively more valuable metal out of circulation3 In a fiat money system a large amount surge of counterfeit ie fake coins andor notes ie the bad money drives the good money the real coinsnotes out of use as people become reluctant to accept such money as a means of payment as they fear they are likely to be ripped off given the presence of a large amount of fake money ex fake 50 bills drives people from accepting ANY 50 bill as a means of paymentClearly Greshams Law can negatively impact ANY payments system such as one based on either commodity or fiat money it certainly also applies to chequeselectronic payments means as wellie electronic money stored value cards etc If a monetary payments system is hit with Greshams Law problems that undermines this payments system by reducing peoples willingness to accept this type of moneycredit as a means of payment If the problem gets large enough people will refuse to accept this type of money as payment and this payments system completely breaks down ie this is an example of systemic riskwhich has caused the affected asset to no longer function as the medium of exchangewhich means this asset is no longer money
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