Unit 4: Money & the functions of the FED

Money, Time value of money, & what banks do followed by their functions of the FED

I. Uses of Money

* Media of Exchange- trade or barter 

* Unit of account- establishes economic worth in the exchange process. 

* Store of value- money holds its value over a period of time whereas products may not. 

II. Types of Money

- Commodity money- it gets its value from the type of material from which it is made. Example: gold and silver coins

- Representative money- paper money backed by something tangible that gives it value. Example ($100)

- Fiat money- it is money because the government says so... (Money we use in the U.S.)

III. Characteristics of Money

* Durable 

* Portable 

* Divisible 

* Uniformed

* Scarce 

* Acceptable 

IV. Money Supply 

- M1 money supply- consists of currency, checkable deposits (demand deposits) also followed by with a travelers check. (75 percent of the money we use comes from M1 money) **out of all the three this is the most "liquid" meaning easy to break down.

- M2 money supply- consists of M1 money (+) savings accounts (+) deposits held by the banks outside of the U.S. (Saving accounts are not liquid...) meaning not easy to break down. 

- M3 money supply- consists of M2 money (+) certificate of deposits that are held by private institutions.

Time Value of Money (03/09/2016) 

* Is a dollar today worth more than a dollar tomorrow? 

- Yes.

- Why?

_ Opportunity cost and inflation. This is the reason for changing and paying interest. 

Calculating time value of money 

V= future value of $

P= present value of $

r= real interest rate (nominal-inflation rate) expressed as a decimal 

n= years 

k= number of times interest is credited per year

* The simple interest formula 

v= (i+r)^n times p

* The compound interest formula 

v= (i+r/k)^nk times p

Money Demanded v. Money Supply 

* Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded. 

1. What happens to the quantity demanded of Mekong when interest rates increase? 

- Answer: Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed inabilities. 

2. What happens to the quantity demanded when interest rates decrease? 

- Answer: Quantity demanded increases. There is no incentive to convert in cash into interest earning assets. 

The Demand for Money 

- always downward sloping 

* What happens if price level increase? 

_ Demand for money will also increase to the right. 

3 ways that will cause money demand to shift???

1. Change in price level

2. Change in income

3. Changes in taxation that affects investment

Increasing Money Supply 

- always vertical (top) shift to the right

How does this affect AD?

- Answer: if money supply increase, interest rate decrease, investment increase and AD increases (what does this show? You guys know (Relationship) 

Decreasing Money Supply (left)

- How does this affect AD? 

* Answer: interest rate increase, investment decrease, AD decrease (once again this shows a Relationship)

Financial Sector 

Financial Assets v. Financial Liabilities 

1. Financial Assets consists of (Stocks, bonds, provide and expected future benefits) (it's what you own) 

2. Financial Liabilities is basically (what you owe?)

Interest rate- the cost of borrowing money 

Stocks v. Bonds

Stocks: financial assets that conveys ownership in a company.

Bonds: a promise to pay a certain amount of money plus interest in the future...

What Banks Do?

* A bank is a financial intermediary 

- uses liquid assets (bank deposits) to finance the investments of borrowers. 

* Process is known as Fractional Reserve Banking 

- it's a system in which depositing institutions hold liquid assets less than the amount of deposits. 

Can take the form of...?

1. Currency in bank vaults 

2. Bank reserves- deposits held at the Federal Reserve 

What Banks Do...? (Continued)

Basic Accounting Review 

* T Account (Balance sheet) 

(Statements of assets and liabilities)

- Assets (account owned) items to which a bank holds equal claim. Also the use of funds by financial intermediaries. 

- Liabilities (amount owned) the legal claims against a bank. Also the spruces of funds for financial intermediaries. 

03/10/2016 Functions of FED 

1. To issue paper currency 

2. Set reserve requirement and hold reserves of banks

3. To lend money to banks and charge them interest 

4. They are a check clearing serving for banks 

5. Acts as a personal bank to the Government 

6. Supervises member banks

7. Controls money supply in the economy