Money Mediums of Exchange The Functions of Money

Money Mediums of Exchange

The Functions of Money has three principle purposes: • Medium of exchange • Standard object – exchange goods or services • Unit of account • Standard unit – quoting prices • Store of value • Store wealth

Six Characteristics of Money • Coins and Paper bills used as money are called currency. There are six characteristics of currency: • Durability • Portability • Divisibility • Uniformity • Limited Supply • Acceptability

Sources of Money’s Value • As convenient and practical as they may be, bills and coins have very little value in and of themselves • There are three possible sources of value depending on what currency is being used: • Commodity Money • Representative Money • Fiat Money

Commodity Money • Commodity money consists of objects that have value in and of themselves but are also used as money. • Cattle • Salt • Precious stones • Cigarettes • Commodity money only works in simple economies because it is not portable, durable, or divisible

Representative Money • Representative money makes use of objects that have value because the holder can exchange them for something of value • IOU • Gold/Silver certificates • This type of currency fell out of favor because they force the government to keep vast supplies of gold and silver if a sudden demand arose

Fiat Money • Fiat money, also called “legal tender”, has value because the government has decreed that it is an acceptable means to pay debts • Regulated by the Federal Reserve

Inflation • Inflation is a general increase in prices. It happens as the purchasing power of money declines over time • Inflation Rate: Percentage rate of change in price level over time

Inflation • • There are several theories as to the cause of inflation: Quantity Theory Demand-Pull Theory Cost-Push Theory

Quantity Theory • The Quantity Theory of inflation states that too much money in the economy causes inflation. • The money supply needs to be carefully monitored to keep it in line with the nation’s productivity as measured by real GDP

Demand-Pull Theory • The demand-pull theory states that inflation occurs when demand for goods and services exceeds the existing supplies • Wartime • Embargo

Cost-Push Theory • According to the cost-push theory, inflation occurs when producers raise prices in order to meet increased costs • Increases in costs lead to increases in prices which lead to more increases in costs • Wage-Price Spiral

Effects of Inflation • High inflation is a major economic problem: • Purchasing Power declines • Income cannot match devaluation • Interest Rate: Holing lose value and become worth less than investment