TOPIC MONEY AND PRICES IN THE LONG-RUN Institute of International Education 3.1 The monetary system This section will help you: ▪ Define money and discuss its functions ▪ Discuss the definition of the money supply ▪ Explain how financial institutions create money ▪ Understand tools of Monetary Control Institute of International Education Trade without money ▪ Trade without money is known as direct exchange, or barter ▪ Barter is inefficient because there must be a coincidence of wants For trade to take place, each must want what the other person has, and must be willing to trade for it ▪ Most people have to spend time searching for others to trade with – a huge waste of resources Institute of International Education Indirect Trade ▪ This searching is unnecessary with money, ▪ It facilitates production and trade: people accept money for their own products, and then use money to purchase other goods and services Money makes trade much more efficient Institute of International Education Money Money: the set of assets in an economy that people regularly use to buy g&s from other people Medium of exchange Institute of International Education Unit of account Store of value The Functions of Money ▪ Medium of exchange: an item buyers give to sellers when they want to purchase g&s ✓ Liquidity to describe the ease with which an asset can be converted into the economy’s medium of exchange ▪ Unit of account: is an agreed measure for ▪ stating the prices of g&s and record debts Store of value: an item people can use to transfer purchasing power from the present to the future Institute of International Education The Kinds of Money Commodity money: takes the form of a commodity with intrinsic value Examples: gold, silver, shell, cigarettes… Fiat money: money without intrinsic value, is used as money because of government decree Example: the U.S dollar Institute of International Education The Money Supply ▪ The money supply (or money stock): the quantity of money available in the economy ▪ Assets should be considered as part of MS: ▪ 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 check or swiping a debit card Institute of International Education Measures of the Money Supply Defines money according to its liquidity The two most commonly used measures of the money stock, designated M1 and M2 ▪ Savings deposits ▪ Small time deposits ▪ Money market mutual funds ▪ Demand deposits ▪ Traveler’s checks ▪ Other checkable deposits ▪ Everything in M1 ▪ Currency M1 Institute of International Education M2 Central Banks & Monetary Policy ▪ Central bank: an institution that oversees the banking system and regulates the money supply ▪ Monetary policy: the setting of the money supply by policymakers in the central bank ▪ Federal Reserve (Fed): responsible for regulating the system - an example of central bank in U.S Institute of International Education .. .3. 1 The monetary system This section will help you: ▪ Define money and discuss its functions ▪ Discuss the definition of the money supply ▪ Explain how financial... system and regulates the money supply ▪ Monetary policy: the setting of the money supply by policymakers in the central bank ▪ Federal Reserve (Fed): responsible for regulating the system - an example... ▪ Other checkable deposits ▪ Everything in M1 ▪ Currency M1 Institute of International Education M2 Central Banks & Monetary Policy ▪ Central bank: an institution that oversees the banking system