WEEK 1 EC315 Monetary Economics

Chapter 1 L-M
1.2 The Functions of Money
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"mportant to %e a%&e to e'press an( compare the )a&ues of (ifferent *oo(s an( ser)ices
*oo( for economic efficiency. Without money+ the umer of ca&cu&ations re,uire( to
achie)e the )a&uation of *oo(s in terms of *oo(s increases sharp&y -ith the num%er of
commo(ities in)o&)e(. T=1/2 n (n-1)
1. is to a)oi( such unnecessary ca&cu&ations
2. to permit rationa& economic ca&cu&ations to ta.e p&ace e.*. a&&o-s compara%i&ity
-ith a common unit of account
3. is to transmit economic information. /rices inform househo&(s (eman( for their
ser)ices etc
0. unit of contract -hene)er a purchase is ma(e -ithout payin* cash purchaser is
,uote( money a contract to pay ater
1#WE2E3+ money is inf&ationary its unit of account is not constant.
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Money a&&o-s us to a)oi( the incon)enience of %arter e'chan*e economy.
1. 7imp&ifies transactions %arter is )ery comp&e'. "ts comp&e'ity stems from it
%ein* %oth a sa&e an( a purchase an( so in)o&)in* t-o economic (ecisions8
-hat+ ho- much+ an( on -hat terms to se&&9%uy. This comp&icates the (ecision
process %y (ou%&in* the num%er of )aria%&es that eners into it.
2. Money rep&aces %i&atera& tra(in* -ith mu&ti&atera& tra(in*+ re(ucin* the
num%er of transactions nee(e( to achie)e a *i)en (e*ree of specia&isation.
Money is a time sa)er ena%&in* peop&e to se&& to ne person an( %uy from
another.
3. The use of money increases the num%er of simi&ar transactions+ an( the
simi&arity of terms of contract enhances competition. E.*. one thousan(
peop&e %uyin* %rea( -ith money more competition &o-er prices.
:C#MM!"T; F$"363#!4< -here in(i)i(ua&s meet other in(i)i(ua&s (esirin*
to en*a*e in commo(ity tra(e
Transaction costs cou&( %e re(uce( further y esta%&ishin* -ithin the fair*roun( a
separate :tra(in* post< for each (istinct pair of commo(ites tra(e(. "f pro)ision -ere
ma(e for (irect tra(in* of each *oo( for e)ery other *oo(+ a -e&&-or*ani=e( %arter
economy -ou&( (e)e&op up to n>n-1?92 mar.ets in n commo(ities.
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Money has the characteristics of an asset -ith constant nomina& purchasin* po-er the
capita& )a&ue of -hich (oes not f&uctuate -ith the rate of interest. $s a me(ium of
e'chan*e+ money ena%&es a person to %uy e&se-here+ other than -here he or she se&&s.
The *reater cost an( incon)enience of storin* *oo(s instea( of money+ the
(eterioration an( o%so&escence of *oo(s store(.
Comp&e' or*anisationa& units+ such as fami&ies+ firms+ %an.s+ *o) etc cannot easi&y
coor(inate p&ans for se&&in* an( %uyin*. This *i)es rise to possi%&e (iscrepancies
%et-een receipts an( payments that can cause consi(era%&e f&uctuations in cash
ho&(in*s. The purpose of ho&(in* cash reser)es is precise&y so that cash reser)es on
han( can %e use( to ma.e transaction sas the nee( arises+ to ta.e a()anta*e of a *oo(
opportunity+ or to ti(e o)er an emer*ency. The costs of a &i,ui(ity shorta*e can %e
hi*h.
Financia& assets is a&so a store of )a&ue.