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Chapter 3

MGEC71H3 Chapter Notes - Chapter 3: Longrun, Smart Card, Business Cycle

Economics for Management Studies
Course Code
Jack Parkinson

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Chapter 3: What is Money?
1. Money (Definition):
a) Money - anything that is generally accepted in payment for goods &
services OR in the repayment of debts; a stock concept (at a given
point of time)
b) Wealth - the total collection of all pieces of property that serve to
store value (money, stock, bonds, art real estate etc)
c) Income - flow of earnings per unit of time
d) An even broader definition of money (than simply coins & notes in
circulation) is often needed because other items such as savings
deposits can in effect function as money if they can be quickly and
easily converted into currency OR chequing account (demand)
2. Function of Money
a) Medium of Exchange
i. Money in the form of currency (coins & notes), cheques or
demand deposits is used to pay for goods & services in most
market transactions in an economy
ii. Function as Medium of Exchange
1. Money promotes economic efficiency by minimizing the
time spent in exchanging goods and services (lower
transaction cost)
2. Money also promotes productive efficiency by allowing
people to specialize in what they do best (specialization &
the division of labour) with time saved from producing a
whole array of goods & services to trade under barter
3. Money is essential in an economy because by acting as a
means of payment it provides liquidity which acts as a
lubricant that allows the economy to run more smoothly by
lowering production & transaction costs
b) Unit of Account
i. Used to measure value (of assets & liabilities) in the economy
ii. Function as Unit of Account
1. introduce money (a single reference good) into the economy
and have all prices quoted in terms of units of that money
2. Using money as a unit of account reduces transaction
costs in an economy by reducing the number of prices that
need to be considered and the benefits of this function of
money grow as the economy becomes more complex
c) Store of Value
i. Used to save purchasing power; most liquid of all assets but loses
value during inflation
ii. Money acts as a repository of purchasing power from the
time income is received until the time it is spent

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iii. Function as Store of Value
1. Money is not unique as a store of value in which other
assets like bonds, stocks, and real estate are not only used to
store wealth, but also have advantages over money when
they often pay the owner a higher interest rate, experience
price appreciation, and deliver services such as providing a
roof over one’s head
2. One characteristic that money has as a store of value in which
other assets lack is liquidity (the relative ease and
speed with which an asset can be converted into a
medium of exchange)
3. Liquidity is highly desirable and money is the most
liquid asset of all because it is the medium of exchange
itself (whereas other assets involve transaction costs when
they are converted into money)
4. How good a store of value money is depends on the price
level because its value is fixed in terms of the price level
(doubling the price level will cut the real value of money in
5. During an inflation, price level is increasing rapidly, money
loses value rapidly, and people will be more reluctant to hold
their wealth in this form (at least in domestic currency form).
Transaction declines and barter becomes dominant. Output in
the economy fell sharply during hyperinflation when
transaction costs skyrocketed
3. Evolution of the Payments System
a) Payments system is the method of conducting transactions in the
b) Gresham’s Law
i. The bad money drives out the good (money)
c) Barter
i. Barter is the direct exchange (trade) of goods & services for
goods & services
ii. Pros Allows agents to obtain a wider array of goods & services
(i.e. do not have to be self-sufficient). More prod’n specialization
& jobs
iii. Cons There can be significant search costs (looking for a double
coincidence of wants), high transactions costs, lots of relative
prices (& these can be volatile), problems of indivisibilities & lack
of anonymity
d) Commodity Money (Gresham’s Law)
i. Commodity money Money made up of (or backed by)
precious metals or some other valuable commodity (any
object that clearly has value to everyone is likely candidate to
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