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Economics 1022A/B
Jeannie A Gillmore

Economics – Textbook Notes Chapter 24 – Money, the Price Level, and Inflation What is Money?  Money is any commodity or token that is generally acceptable as a means of payment  A means of payment is a method of settling a debt o When a payment has been made, there is no remaining obligation between the parties to a transaction  Money serves three other functions: o Medium of exchange o Unit of account o Store of value Medium of Exchange  A medium of exchange is any object that is generally accepted in exchange for goods and services  Without it, goods and services must be exchanged directly for other goods and services – an exchange called barter o A barter requires a double coincidence of wants, which rarely occurs Unit of Account  A unit of account is an agreed measure for stating the prices of goods and services  To get the most out of your budget, you have to figure out whether seeing one more movie is worth its opportunity cost o It is easy to do such calculations when all these goods have prices in terms of dollars and cents Store of Value  Money is a store of value in the sense that is can be held and exchanged later for goods and services  The more stable the value of a commodity or token, the better is can act as a store of value and the more useful it is as money o The value of the commodities and tokens that are used as money fluctuate over time  Inflation lowers the value of money and the values of other commodities and tokens that are used as money Money in Canada Today In Canada today, money consists of:  Currency  Deposit at banks and other depository institutions Currency  The notes and coins held by individuals and businesses are known as currency o Notes are money because the government declares them soDeposits  Deposits of individuals and businesses at banks and other depository institutions, such as trust and mortgage companies, credit unions, and caisses populaires, are also counted as money  Deposits are money because the owners of the deposits can use them to make payments Official Measures of Money  Two official measures of money in Canada today are known as M1 and M2 o M1 consists of currency and chequable deposits of individuals and businesses  M1 does not include held by banks or the government of Canada o M2 consists of M1 plus all other deposits  Cheques and credit cards are not money The Banking System  The banking system consists of private and public institutions that create money and manage the nation’s monetary and payments systems  There are three types of these institutions: o Depository institutions o The Bank of Canada o The payments system Depository Institutions  A depository institution is a private firms that takes deposits from households and firms and makes loans to other households and firms  The deposits of three types of depository institutions make up the nations money. They are: o Chartered banks o Credit unions and caisses populaires o Trust and mortgage loan companies Chartered Banks  A chartered bank is a private firm, chartered under the Bank Act of 1992 to receive deposits and make loans Credit Unions and Caisses Populaires  A credit union is a cooperative organization that operates under the Cooperative Credit Association Act of 1992 and that receives deposits from and makes loans to its members  A caisses populaires is a similar type of institution that operates in Quebec Trust and Mortgage Loan Companies  A trust and mortgage loan company is privately owned depository institution that operates under the Trust and Loan Companies Act of 1992  These institutions receive deposits, make loans, and act as trustees for pension funds and for estates What Depository Institutions Do  Depository institutions provide services such as cheque clearing, account management, credit cards, and Internet banking, all of which provide an income form service fees  Earn most of their income by using the funds they receive from depositors to make loans and buy securities that earn a higher interest rate than that paid to depositors o Reserves  notes and coins that are kept in a vault o Liquid Assets  can be sold and instantly converted into reserves o Securities  bonds– can be converted into reserves at prices that fluctuate o Loans  commitments of funds for an agreed-upon period of time Economic Benefits Provided by Depository Institutions  There are four benefits that make these institutions provide that make deposits willing to put up with a low interest rate, and borrowers willing to pay a higher one o Create Liquidity o Pool Risk o Lower the Cost of Borrowing o Lower the Cost of Monitoring Borrowers The Bank of Canada  The Bank of Canada is Canada’s central bank, a public authority that supervises other banks and financial institutions, financial markets, and the payments system, and conducts monetary policy  The Bank of Canada is special in three important ways: o Bankers to banks and governments o Lender of last report o Sole issuer of bank notes Bankers to Banks and Government  The Bank of Canada has a restricted list of customers. They are: o Chartered banks, credit unions and caisses populaires, and trust and mortgage loan companies that make up the banking system o The government of Canada o The central banks of other countries Lender of Last Resort  It is the lender of last resort, which means that it stands ready to make loans when the banking system as a whole is short of reserves Sole Issuer of Bank Notes  The Bank of Canada is the only bank that is permitted to issue bank notesThe Bank of Canada’s Balance Sheet  The Bank of Canada influences the economy by changing interest rates o To influence interest rates, the Bank must change the quantity of money in the economy  The Bank of Canada’s Assets o 2 main assets:  Government securities  Loans to depository institutions  The Bank of Canada’s Liabilities o 2 main liabilities:  Bank of Canada notes  Depository institution deposits The Monetary Base  The monetary base is the sum of Bank of Canada notes, coins, and depository institution deposits at the Bank of Canada  To change the monetary base, the Bank of Canada conducts an open market operation, which is the purchase or sale of government of Canada securities – treasury bills and bonds – by the Bank of Canada in the open market The Payments System  The payments system is the system through which banks make payments to each other to settle transactions by their customers  The payment system enables banks to make payments to each other o This system in Canada is operated by the Canadian Payments Association (CPA) and the CPA owns and operates the two nations payments systems:  Large Value Transfer System  Automated Clearing Settlement System Large Value Transfer System  The large value transfer system (LVTS) is an electronic payment system that enables financial institutions and their customers to make large payments instantly and with the sure knowledge that the payment has been made Automated Clearing Settlement System  The automated clearing settlement system (ACSS) is the system through which all payments not processes by the LVTS are handled How Banks Create Money Creating Deposits by Making Loans  By using a credit card, the bank is giving you a small loan equal to the amount you just spent o The banking system has an increase in loans and deposits by no change in reser
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