Part 1: Types and functions of money.
Three types of money are : Commodity money (for example some parts of Africa where cows are used as money), Representative money (gold money), FIAT money (backed by the word of the govt. if the government says it has value then it has value). functions of money include ; medium of exchange, store of value and unit of account (price implies worth; which isn't always true).
Part 3: Money market graphs.
When price is high quantity demanded is low and when the price is low quantity demanded is high. the supply of money on the graph is vertical because it does not vary based on the interest rate and it is controlled by the FED. Demand of money is tied into the interest rate while supply of money is not. Supply of money moves only when the FED does something to move it. Also, shifting money supply to the right stabilizes interest rate.
Part 4: The FEDs tools of Monetary Policy.
Reserve requirement: is the percentage of bank total deposit that they must hang on to (vault cash).
Discount rate: is the rate at which banks can borrow money from the FED . the FED is a "lender of last resort".
FED funds rate: this has nothing to do with the FED. it is the rate at which banks borrow from each other.
Expansionary (easy money):
RR- decreased in order to increase money supply.
DR- decreased
buy/sell/bonds/seurities: buy bonds to increase money supply.
Contractionary (tight money):
RR - increased
DD- increased
Bonds- sell bonds to decrease Money supply.
Part 5: The equation of exchange.
MV=PQ
M= Money supply
V= Velocity (how fast its moving)
Q= Total Quantity (volume of goods).
when talking about price and quantity then we are talking about the GDP income approach. If velocity is stable, changes in money supply will lead to change in prices.
Part 6: Costs of Inflation.
1. Inflation fallacy: when inflation occurs money power isn't lost because wages will adjust and you get payed more money, therefore there is no real impact of inflation. In the "long run" this is true.
2. Shoe Leather cost.
3. Menu cost: cost of changing prices and communicating those price to customers.
4. Tax Distortions: does not tax your real income but nominal income, it is not adjusted for inflation.
5. Confusion (tied to in adequate information): people do not have a better understanding on the real concept of inflation and so they get misinformed from the media.
6. Redistribution of wealth.
Part 7: The Loanable funds market.
This is the money available in the banking system for people to borrow. Supply of loan-able funds comes from the amount of money people have in banks, this means that it is dependent on savings. In this market, the more money people save, the more money banks have to give out loans. If people have an incentive to save, then we increase the supply of loanable funds. if people have the incentive to save less we decrease the supply of loanable funds. Shifting the supply of loanable funds goes left and to the right and not up and down on the graph.
Part 8: Money creation and multiple deposit expansion.
Banks create money by making loans. One of the FED tools for monetary policy is the ability to control the reserve requirement.
- Money multiplier = 1/RR
RR= 20%, loan amount = $500
What is the total money created? 1/0.2 = 5 * 500 = $2500.
we got $2500 using the process of Multiple deposit expansion.
Part 9: Relating the money market, loanable funds market, and aggregate demand-aggregate supply model.
In the money market the govt is borrowing money from Americans. Whenever someone buys a govt bond thats you loaning your money to the government. In the Money Market, we have an increase in the demand of money because the govt is borrowing it. So this means that the demand of money Shifts to the right and there is an increase in the interest rate. In loan-able funds, demand shifts to the right and there is an increase in the interest rate when there is an increase in govt spending. There is an increase in price level, AD and GDP.
All three graphs are all closely related.
Fisher Effect: 1% increase in interest rate will lead to a 1% increase in inflation (price level).
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