LU2 Chapter 14: The monetary sector
LO1: Define money
LO2: Describe the functions of money
LO3: Discuss the process of different forms of money
LO4: Define the M1, M2 and M3 money aggregates
LO5: Discuss the functions of the South African Reserve Bank
LO6: Discuss the factors which influence
1. The supply of money (how money is created)
2. The demand for money
LO7: Explain the causes of changes in equilibrium in the money market
LO8: Discuss the instruments of monetary policy
,LO1: Define money
Money is anything that is generally accepted as payment for goods and services or
that is accepted in settlement of debt
Definition actually says that money is what money does
i.e. it is defined i.t.o. its main function
it is accepted as payment because people believe that it will be accepted as payment
by other people
LO2: Describe the functions of money
Money as a medium of exchange
Look at the functioning of the barter economy: goods can only be exchanged for
other goods
E.g. if David has a lot of apples from the tree in his garden, but he needs milk, he can
trade his apples for milk
The problem is that he needs to find someone that has a lot of milk and NEEDS or
WANTS apples
Sometimes you will need to trade with others first to get the necessary good
to trade for milk
This is called double coincidence of wants
Due to the inefficiency and high transaction costs of a barter system, people started
to use different forms of money
In a monetary economy a double coincidence is no longer needed
Money acts as an intermediary and is thus a medium of exchange
Money as a unit of account
A unit of account is an agreed measure for stating the prices of goods and services
In a monetary economy these are all expressed in monetary terms
i.e. money functions as a unit of account
allows for a common measure of the cost of various goods and services to decide
how to spend our income and what we can afford
allows us to measure the total value of all goods and services produced in the
economy
money is not the only possible unit of account, the item used as a medium of
exchange (money) is the most convenient unit of account
the function of money as a unit of account is closely linked to its function as a
medium of exchange
usually fulfils the same function
, accounting unit function is secondary to the medium of exchange function as money
can lose some usefulness as a unit of account during inflation
Money as a store of value
There is a need to hold wealth (or surplus production) in some form or another
Money can always be exchanged for other goods and services later
Makes it a common form for holding wealth
Advantage of using money as a store of value:
it is convenient and can usually be used immediately in exchange for other
assets
Money is the most liquid form in which wealth can be kept
Disadvantages:
In times of high inflation money loses its purchasing power and is a bad store
of value
During inflation there is thus a tendency to use other objects as stores of value: fixed
property, shares, works of art
i.e. unlike the medium of exchange function, the store of value function is not
unique to money
the store of value function implies that money serves as a standard of
deferred payment
e.g. if you borrow money to buy a house, your future commitment will be
agreed to in rand and cents
What money is not
Money should not be confused with income or wealth
Income: the reward earned in the production process
Natural resources, labour, capital and entrepreneurship are rewarded in the
form of rent, salaries, interest and profit
The fact that income is calculated and paid in monetary terms is coincidental
Wealth: consists of assets that have been accumulated over time
Can take many forms e.g. fixed property, shares, oriental carpets, paintings
etc.
Can also take the form of money and is usually also calculated in monetary
terms
Money forms a part of wealth, but wealth consists of other assets too
LO3: Discuss the process of different forms of money
LO1: Define money
LO2: Describe the functions of money
LO3: Discuss the process of different forms of money
LO4: Define the M1, M2 and M3 money aggregates
LO5: Discuss the functions of the South African Reserve Bank
LO6: Discuss the factors which influence
1. The supply of money (how money is created)
2. The demand for money
LO7: Explain the causes of changes in equilibrium in the money market
LO8: Discuss the instruments of monetary policy
,LO1: Define money
Money is anything that is generally accepted as payment for goods and services or
that is accepted in settlement of debt
Definition actually says that money is what money does
i.e. it is defined i.t.o. its main function
it is accepted as payment because people believe that it will be accepted as payment
by other people
LO2: Describe the functions of money
Money as a medium of exchange
Look at the functioning of the barter economy: goods can only be exchanged for
other goods
E.g. if David has a lot of apples from the tree in his garden, but he needs milk, he can
trade his apples for milk
The problem is that he needs to find someone that has a lot of milk and NEEDS or
WANTS apples
Sometimes you will need to trade with others first to get the necessary good
to trade for milk
This is called double coincidence of wants
Due to the inefficiency and high transaction costs of a barter system, people started
to use different forms of money
In a monetary economy a double coincidence is no longer needed
Money acts as an intermediary and is thus a medium of exchange
Money as a unit of account
A unit of account is an agreed measure for stating the prices of goods and services
In a monetary economy these are all expressed in monetary terms
i.e. money functions as a unit of account
allows for a common measure of the cost of various goods and services to decide
how to spend our income and what we can afford
allows us to measure the total value of all goods and services produced in the
economy
money is not the only possible unit of account, the item used as a medium of
exchange (money) is the most convenient unit of account
the function of money as a unit of account is closely linked to its function as a
medium of exchange
usually fulfils the same function
, accounting unit function is secondary to the medium of exchange function as money
can lose some usefulness as a unit of account during inflation
Money as a store of value
There is a need to hold wealth (or surplus production) in some form or another
Money can always be exchanged for other goods and services later
Makes it a common form for holding wealth
Advantage of using money as a store of value:
it is convenient and can usually be used immediately in exchange for other
assets
Money is the most liquid form in which wealth can be kept
Disadvantages:
In times of high inflation money loses its purchasing power and is a bad store
of value
During inflation there is thus a tendency to use other objects as stores of value: fixed
property, shares, works of art
i.e. unlike the medium of exchange function, the store of value function is not
unique to money
the store of value function implies that money serves as a standard of
deferred payment
e.g. if you borrow money to buy a house, your future commitment will be
agreed to in rand and cents
What money is not
Money should not be confused with income or wealth
Income: the reward earned in the production process
Natural resources, labour, capital and entrepreneurship are rewarded in the
form of rent, salaries, interest and profit
The fact that income is calculated and paid in monetary terms is coincidental
Wealth: consists of assets that have been accumulated over time
Can take many forms e.g. fixed property, shares, oriental carpets, paintings
etc.
Can also take the form of money and is usually also calculated in monetary
terms
Money forms a part of wealth, but wealth consists of other assets too
LO3: Discuss the process of different forms of money
