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Chapter 10 – The Monetary System
Barter – the exchange of one good or service for another – to obtain the things they need.
An economy that relies on barter will have trouble allocating its scarce resources
In such an economy, trade is said to require the double coincidence of wants – the unlikely
occurrence that two people each have a good or service that the other wants.
The meaning of money
Money: the set of assets in an economy that people regularly use to buy goods and services
from other people.
If you owned the Microsoft Corporation, you would be wealthy, but this asset is not
considered a form of money. You could not buy a meal or a shirt with this wealth, without
first obtaining some cash.
According to economist’s, money includes only those few types of wealth that are regularly
accepted by sellers in exchange for goods and services.
The functions of money
Money has three functions in the economy:
Medium of exchange
Unit of account
Store of value
Medium of exchange: an item that buyers give to sellers when they want to purchase
goods or services.
Unit of account: the yardstick people use to post prices and record debts.
Store of value: an item that people can use to transfer purchasing power from the present
to the future. The term wealth is used to refer to the total of all stores of value, including
both money and nonmonetary assets.
Liquidity: the ease with which an asset can be converted into the economy’s medium of
exchange. Because money is the economy’s medium of exchange, it is the most liquid asset.
Most stocks and bonds can be sold easily with small cost, so they are relatively liquid.
Selling a house, painting or hockey card requires more time and effort thus are less liquid.
The kinds of money
Commodity money: money that takes the form of a commodity with intrinsic value
Intrinsic value – the item would have value even if it were not used as money.
Example of commodity money: gold – has intrinsic value because it is used in industry and
in the making of jewelry.
When an economy uses gold as money it is said to be operating under a gold standard.
Fiat money: money without intrinsic value that is used as money because of government
Fiat – simply an order or decree, and fiat money is established as money by government
Example, dollars in wallet and monopoly dollars – you can use the ones in your wallet to
pay your bill at a restaurant because the Canadian government has decreed its dollars to be
valid money. Each paper dollar in your wallet reads: “This note is legal tender.”
Money in the Canadian economy
Money stock – quantity of money circulating in the economy – has a powerful influence on
many economic variables.
Currency: the paper bills and coins in the hands of the public.
Demand deposits: balances in bank accounts that depositors can access on demand by
writing a cheque or using a debit card.
Two measures of the money stock for the Canadian economy:
o Chequable deposits
o Nonpersonal demand and notice deposits
o A few minor categories
o Everything in M1+
The Bank of Canada
Bank of Canada: the central bank of Canada.
Central bank: an institution designed to regulate the quantity of money in the economy.
The Bank of Canada act
Up until the Great Depression, Canada had no central bank.
The economic problems of the Great Depression and the need to control the quantity of fiat
money when the hold standard collapsed, led the government to set up a royal commission
to study the issues. The commission recommended that a central bank be established.
Bank of Canada act – 1934
Bank established – 1935
Nationalized – 1938
BOC is managed by a board of directors composed of the governor, the senior deputy
governor, and 12 directors, including the deputy minister of Finance.