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Content Objective:
Explain money and the factors that determine its value.
Language Objectives:
- Understand, learn, and use new vocabulary that is introduced and taught directly through informational text and direct instruction.
- Identify and/or summarize main ideas, facts, supporting details, and opinions in an informational and/or practical selection.
- Read and synthesize information found in various parts of charts, tables, or diagrams to reach supported conclusions.
Learning Target:
Students will explain the purpose and functions of money in the economy
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What is Money
The concept of money and the usage and the amount of money in circulation are ideas that most people take for granted. Without money, people would have to barter, or exchange goods and services for other goods and services.
Products and services obtained through bartering, rely on a double coincidence of wants. People want what you had and you wanted what they had. Through barter, there is no exchange of money. Does this make money obsolete? Not at all. If anything, it shows how much we need money. With money, you don’t need coincidence to get things you want. Producers gladly accept money in return for goods and services. Money is anything that is generally accepted as a means of payment. Money functions in three key ways: as a medium of exchange, as a standard of value, and as a store of value.
Money Has Three Basic Functions
Money is a medium of exchange. It enables us to carry out trade and commerce more easily than through barter. Rather than finding someone willing to trade, you can buy a new backpack just by handing the store clerk a quantity of dollars, the established medium of exchange in the United States. U.S. dollars are the country’s legal tender and must be accepted as money for purchases and as payment for a debt.
Money also serves as a standard of value. It allows us to measure and compare the value of all kinds of goods and services using one scale. If we had no standard of value, it would be much harder to compare prices. Imagine seeing advertisements from two stores. One advertises a backpack for sale eight pairs of shoes. The other has the same backpack advertised for six T-shirts. Without a common standard of value, how would you know which backpack costs more?
Something is a store of value if it holds its value over time. A banana would be a poor store of value because it spoils quickly. A rotten banana has lost much or all of its original value. However, money holds its value over time. Money maintains its purchasing power. Purchasing power refers to the quantity of goods and services that can be bought with a particular sum of money. The $10 you have in your pocket today will buy $10 worth of goods and services now and for some time into the future. This stability allows you to hold onto your money, knowing you can spend it just as well tomorrow as today. Although money stores value very well, it is not a perfect store of value, because prices tend to rise over time. Five dollars will get you five dollars of pencils, but the number of pencils you can get may decrease over time.
Money Has Six Main Characteristics
For money to perform its three primary functions well, whatever we use as money should exhibit these six characteristics.
The most important characteristic of money is acceptability. In order for you to buy something, the seller must be willing to accept what you offer as payment. In the same way, when you sell your services, your labor, you must be willing to accept what your employer offers as payment or waged in exchange.
Whatever is used as money needs to be scarce enough to be valued by buyers and sellers. Many cultures have used gold and silver as a medium of exchange. The relative scarcity of these metals adds o their value. If gold and silver were as common as sand, these metals would cease to be used as money.
To be convenient as a medium of exchange, money must be portable. People must be able to carry it with them easily.
If money is to serve as a store of value, it must be durable. Any medium of exchange must be able to withstand the physical wear and tear of being continually transferred from person to person.
to be useful as a medium of exchange, money must be easily divided into smaller amounts. A bag of salt can be split into ever smaller amounts. This ease of divisibility once made salt a useful medium of exchange.
Uniformity means that all versions of the same denomination of currency must have the same purchasing power. For example, an old $2 bill will still buy $2 worth of goods or services today.
History of Money
Gold, silver, and salt have all served as money at some time in history. So have shells, cattle, beads, furs, and tobacco. Economists categorize all of these items of exchange as commodity money. A commodity is a good that has value in trade and becomes commodity money when it is used as a medium of exchange. The value of the commodity money is about the same as the value of the commodity it consists of.
Commodity money was used for thousands of years, all over the world. Of all the many commodities used as money, precious metals such as gold and silver were historically preferred over other forms of commodity money. These metals had all the useful characteristics of money. They were scarce, portable, durable, divisible and acceptable. In the form of bars and coins, these metals could even be made uniform.
As trade flourished in Europe during the Renaissance, wealthy merchants and nobles needed safe places to store their gold and silver bars and coins. In the larger cities, private banks arose to meet this need. These early banks accepted depositors’ precious metals and in return gave the depositors elaborate paper receipts known as banknotes. The banks promised to exchange these banknotes for gold or silver “on demand,” whenever the holder asked for such an exchange.
Economists call banknotes given in exchange for gold and silver commodity backed money or representative money. The notes have minimal value in and of themselves. You could not eat them, wear them, or otherwise consume them. As representative money, they had value only as a medium of exchange.
These banknotes were the forerunners of modern printed money issued by governments. But there is a big difference between the two. Paper money today is no longer backed by gold, silver, or any other commodity. It has value only because it is generally accepted as a means of payment.
That acceptance comes in part because governments declare that the paper notes they issue are money. You can read this declaration on any bill issued by the U.S. government:
This note is legal tender for all debts, public and private.
In the past, such government decrees were known as fiats. Paper money issued without the backing of gold or silver came to be known as fiat money.
The gold standard, which made all currency convertible into gold on demand, was adopted in 1900 but was abandoned by 1934. U.S. dollars may not be backed by gold or silver, but they are backed by the full faith and credit of the U.S. government. As long as consumers believe they can purchase goods and services with dollars, people will continue to use dollars as a medium of exchange.
What Counts as Money
When most people think of money, they most often think of cash, in the form of paper bills or metal coins. Together, bills and coins circulating throughout the economy are known as currency. However, currency is only part of the nation’s money supply, or total amount of money in the economy.
What else counts as money? The answer depends on the kinds of assets economists choose to count as money in addition to currency. The most common measure of money used by economists today is known as M1. Besides coins and bills, M1 includes liquid assets that can be used as cash or can be converted into cash.
Currency makes up about half of the M1 money supply. Most of the rest consists of what economists call checkable deposits, or deposits in bank checking accounts. Depositors can write checks on these accounts to pay bills or make purchases. Checks themselves are not considered money, but the deposits they access are.
Traveler’s checks are also included in the M1 money supply. Travelers buy these checks and use the checks like cash to pay for goods and services. The M1 money supply is made up of currency, checkable deposits, and traveler’s checks.
Savings account deposits are considered near-money. Although savings account funds can usually be transferred to a checking account fairly easily, they are not used directly to buy things. Because savings are not as liquid as cash, economists put them into a second category known as the M2 money supply. M2 consists of M1 plus money saved in various kinds of accounts or funds.
You can buy a pair of shoes with a credit card. Even though people sometimes call their credit cards “plastic money,” economists do not regard credit cards as a form of money. Each purchase with a credit card creates a loan that the user must pay back to the bank, store, or other business that issued the card. The card is not money.
You can also buy shoes with a debit card. A debit card allows you to access the money in your bank account. Although it is a handy tool for accessing money, a debit card, like a check, is not considered part of the money supply.
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Assignment:
- 8.2 What Makes Money Money (read pp.142-146)
- 8.3 How Does the Banking System Work (read pp.146-150)
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