EC223 Chapter Notes - Chapter 3: Financial Innovation, Life Insurance, Business Cycle

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26 Jan 2013
EC223 Chapter 3 What is Money? Week 3
Meaning of Money
-Economists define money as anything that is generally accepted in payment for goods or services or in
the repayment of debts
-Currency, consisting of dollar bills and coins is one type of money
-Wealth includes not only money but also other assets such as bonds, common stock, art, land,
furniture, cars, and houses
-Income is a flow of earnings per unit of time
Functions of Money
-Money has three primary functions in any economy: as a medium of exchange, as a unit of account, and
as a store of value
Medium of Exchange
-It is used to pay for goods and services
-The use of money as a medium of exchange promotes economic efficiency by eliminating much of the
time spent in exchanging goods and services
-The time spent trying to exchange goods or services is called a transaction cost
-Money is a lubricant that allows the economy to run more smoothly by lowering transaction costs,
thereby encouraging specialization and the division of labour
-For a commodity to function effectively as money, it has to meet several criteria:
-It must be easily standardized making it simple to ascertain its value
-It must be widely accepted
-It must be divisible so that it is easy to “make change”
-It must be easy to carry
-It must not deteriorate quickly
Unit of Account
-It is used to measure value in the economy
-We introduce money into the economy and have all prices quoted in terms of units of that money,
enabling us to quote the price of economic lectures, peaches, and movies in terms of, say, dollars
-Using money as a unit of account reduces transaction costs in an economy by reducing the number of
prices that need to be considered
Store of Value
-It is a repository of purchasing power over time
-Used to save purchasing power from the time income is received until the time it is spent
-Most of us do not want to spend out income immediately upon receiving it but rather prefer to wait
until we have the time or desire to shop
-Liquidity is the relative ease and speed with which an asset can be converted into anything else in order
to make purchases
-Hyperinflation is when the inflation rate exceeds 50% per month
Evolution of the Payments System
-The payments system is the method of conducting transactions in the economy
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