Topic 7 - Money and The Money Market

Money and the Money
Market
TOPIC 7
Learning Outcome
By the end of this chapter, students should be
able to:
• Explain the history of money in economy
• Define the function of money
• Understand the demand and supply of
money
• Define types of money for M1, M2 and M3
• Explain the Money Market (equilibrium and
changes in equilibrium)
Learning Objective
Understand evolution of Money
Define function of Money
The Supply of Money
Defining Money: M1, M2 and M3
Explain the demand and supply for money
Explain the Money Market (equilibrium and changes in equilibrium)
Chapter Outline
• Evolution of Money
• Function of Money
• The Supply of Money
• Defining Money: M1
• Near-money: M2 and M3
• The demand for money:

• The Money Market (equilibrium and changes in equilibrium)
What is Money?
Money is any commodity or token that is generally
acceptable as a means of payment.
Money is the set of assets in an economy that
people regularly use to buy goods and services from
other people.
Money is a good that is accepted as a medium
of exchange in transactions
Evolution of Money
1. COMMODITY MONEY
• different commodities that were used as a medium of exchange
(BARTER SYSTEM)
• Cow Heads, Goats, Axes, Dried Fishes etc were used as medium
of exchange.
2. METALLIC MONEY
• the next step in the evolution was the
discovery of precious metals
• Gold, Silver, Copper or nickel
Evolution of Money
3. PAPER MONEY
• When paper currency was introduced as a mode of payment.
• Originated as a receipt issued by Goldsmiths.
• These receipts were then later on used for payments.
• Refers to the Notes issued by the State or by the Bank, usually the
Central bank.
• 4. CREDIT MONEY
Includes Bank money (different instruments offered by the
Banks.)
• Cheques, Drafts, Purchased order (P.O), Treasury Certificate (T.C)
are examples.
Evolution of Money
5. ELECTRONIC MONEY
• Electronic money (also known as e-money, electronic cash,
electronic currency, digital money, digital cash or digital currency)
refers to money or scrip which is exchanged only electronically.
• Typically, this involves use of computer networks, the internet
and digital stored value systems.
Functions of Money
Standard of value/Unit of account
Measure of the value of all other goods and services
State the prices in terms of money
Allow us to compare the relative values of goods &
services
Medium of exchange
Something that people are willing to accept in payment
for goods and services
Avoids double coincidence of wants
Without a medium of exchange, people would have to
trade their goods & services directly for other goods &
services (barter trading)
Functions of Money
Store of value
Allows conversion of other goods into wealth which can
be stored / retained
Other stores of value include gold, real estate, jewels etc
Money have the advantage of being immediately usable
by people in meeting financial obligations
The Supply of Money
• Money supply is the total amount of
money available in an economy at a
particular point in time.
Supply for Money
Interest Rate (percent per year)
Money supply
The amount of
money supplied
9 E2
not depends on
7 E1 interest rates
0 Qm
Quantity Of Money (billions of dollars)
M1, M2 & M3
M1 = currency + checkable deposits
M2 = M1 + savings deposits + small time deposits + Money market

mutual funds (MMMF)
M3 = M2 + large time deposits

The demand for money
• The demand for money is the relationship
between the quantity of real money demanded
and the nominal interest rate when all other
influences on the amount of money that people
wish to hold remain the same.
Interest rate (% per year)
Effect of an increase in the interest rate
Effect of a decrease in the interest rate
MD
0 Real money (RM trillions)
• The demand for money curve, MD, shows the
relationship between the quantity of real
money that people to hold and the nominal
interest rate, other things remaining the same.
• The interest rate is the opportunity cost of
holding money. A change in the interest rate
brings a movement along the demand for
money curve.
Shifts in the Demand for
Money Curve
Interest rate (% per year)
Effect of increase
in real GDP
Effect of decrease in
real GDP or
financial innovation
0 Real money (RM trillions)

18
Factors Affecting Demand for Money

• The quantity of money • The better the
demanded is financial innovation,
proportional to the the less money will be
price level. demanded. Eg., credit
• Level of price increase, cards, online banking
demand for money etc.
increase. • Technology increase,
The pace of demand for money
Level of financial decrease.
prices innovation
(Technology)
Level of real • Higher income leads

GDP to higher expenditure.
People hold more
money to finance
higher volume of
expenditure.
• Level of GDP
increase, demand for
money increase.
Total Demand for Money
20
18
16
14
12
10
Total demand
8 for money
6
4
2
0 200 400 600 800 1,000 1,200 1,400 1,600 1,800

Quantity of money (in $ billions)
Total Demand of Money (MD)

The Money Market (equilibrium and
changes in equilibrium)
The interest rate of 7.2 20
percent is found at the 18 M

16
intersection of the total 14
demand for money and 12
the supply of money (M) 10
Total demand
8 7.2%
for money
6
Since at any given time the 4
supply of money (M) is fixed 2
it can be represented as a 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800
vertical line Quantity of money (in $ billions)

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Money and the Money

• The demand for money:

M2 = M1 + savings deposits + small time deposits + Money market

M3 = M2 + large time deposits

Effect of an increase in the interest rate

Effect of a decrease in the interest rate

0 Real money (RM trillions)

Factors Affecting Demand for Money

Level of real • Higher income leads

0 200 400 600 800 1,000 1,200 1,400 1,600 1,800

Total Demand of Money (MD)

percent is found at the 18 M

Since at any given time the 4

supply of money (M) is fixed 2

vertical line Quantity of money (in $ billions)

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