The Importance of Money

THE IMPORTANCE OF MONEY

In this topic we will be studying and describing the fundamental role that money plays in facilitating exchange and, thereby, allowing for specialization. Why Specialization? Then you need to think about it: why money leads to specialization? why an economy needs to use money at all . We may also discuss on the disadvantages of barter. The other thing that need to be focused on is measurement of money. Why we have different type of measurement of money supply? What is the purpose? Last and not least the idea of the payments system, that is, a discussion on the evolution of the payments system from precious metals to currency and checks to electronic funds transfer services—such as automated teller machines (ATMs) and debit cards.
For those who be in the forum, try your best to answer the questions that have been given here. These are some of the questions that we are to discuss it in first seminar.

Outline

I. Meeting the Needs of Exchange with Money

A) Money makes exchange more efficient and allows for specialization.
B) The type of exchange known as barter, where goods and services are exchanged directly for other goods and services is inefficient because it incurs high transactions costs.

C) Voluntary trade may be sidestepped by using government allocation to distribute goods and services, but this is unlikely to be successful because it ignores market forces.

D) Money has four key functions that make it the most efficient means of trade:
1. Money acts as a medium of exchange, which is anything that is generally accepted as payment for goods and services or in the settlement of debts.
2. Money is a unit of account, which is a way of measuring value in the economy in terms of money.
3. Money is a store of value, in that it is an asset or a thing of value that can be owned and is, therefore, a component of wealth.
4. Money offers a standard of deferred value in credit transactions. E) The value of money depends on its purchasing power.
1. A decline in the purchasing power of money is known as inflation and an increase in the purchasing power of money is know as deflation.
2. Changes in the value of money over time can be computed using a price index, which is a summary statistic that reflects changes in the price of a group of goods and services relative to the price in a base year.

F) There are five criteria a good must meet to be suitable as a medium of exchange:
1. The good must be acceptable to most traders.
2. It should be of standardized quality.
3. It should be durable.
4. It should be valuable relative to its weight.
5. It should be divisible.

II. The Payments System

A) The mechanism for conducting transactions in an economy is known as a payments system.

B) Definitive money is money that does not have to be converted into a more basic medium of exchange.

C) Physical goods, such as gold and silver, when used to accomplish trade are called commodity money.

D) A system in which the definitive money is money authorized by a central bank or governmental body as legal tender—that is, the money must be accepted to discharge debts and tax payments must be in cash or checks denominated in that money—is known as a fiat money system.

E) Checks are promises to pay definitive money on demand and are drawn on money deposited with a financial institution.
1. Settling transactions with checks requires more steps than settling transactions with cash.
2. Checks are less liquid than cash and there is a cost to using checks.

F) Settling and clearing transactions can now be done with computers in electronic funds transfer systems.
1. Debit cards and automated teller machines are examples of electronic funds transfer devices.
2. Eighty percent of the dollar value of transactions among financial institutions is conducted electronically.

G) The efficiency of the payments system reduces the cost of settling transactions.

III. Measuring the Money Supply

A) Economists have developed different definitions of the money supply based on the differences in the assets included as money.
B) The narrowest definition of the money supply is M1, which includes currency, traveler's checks, and checking account deposits.
C) M2 includes the assets in M1 plus short-term investment accounts.
D) M3 includes the assets in M1 and M2 plus such less liquid assets as large- denomination time deposits, institutional money market mutual fund balances, term repurchase agreements, and others
E) In the 1980s and 1990s economists and policy makers have considered M2 the best measure of the money supply.
F) The monetary aggregates move broadly together over long periods of time, although there have been significant differences in their movements during certain periods.