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Topic: 1. The Importance of Money, Banking, and Financial Markets

Learning 1. Appreciate the importance of money – definition, function,
criteria, payment system.
Targets:
2. Understand barter economy, liquidity and transaction cost.
References: Economics of Money, Banking and Financial Markets by Frederic S.
Mishkin. www.rasabourse.com
1. TO ENGAGE

“It’s not about the money.. money.. money. ♪

We don’t need your money.. money.. money. ♫
We just wanna make the world dance. ♪
Forget about the price tag.” ♫♪

Do you agree with Jessie J when she gradly sing that we don’t need money? How do you acquire
your belongings? What did you do when you have extra money or when you lack of it? How will
you buy what you need if you don’t have enough money to spend? Is there any other means that
I can use aside from coins and bills?

2. TO EXPLORE

Money plays an important role, not only in business but in our day-to-day lives. From the time
we wake up, we need money to buy and prepare for our meals, when we go to school, we need
money to pay for our ride, when we take our rest, we need money to lay us in a comfortable bed.

3. TO EXPLAIN
Sometimes, we have overflowing supply of money, but most of the time, we are short of
it. This chapter, we will elaborate the importance of money, banking and financial
markets.

To verify your answers to the questions above, consider these definitions:

As the word money is used in everyday conversation, it can mean many things, but to
economists, it has a very specific meaning. To avoid confusion, we must clarify how economists’
use of the word money differs from conventional usage.

Economists define money (also referred to as the money supply) as anything that is generally
accepted in payment for goods or services or in the repayment of debts.

Currency, consisting of dollar bills and coins, clearly fits this definition and is one type of
money. When most people talk about money, they’re talking about currency (paper money and
coins). If, for example, someone comes up to you and says, “Your money or your life,” you
should quickly hand over all your currency rather than ask, “What exactly do you mean by
‘money’?”

To define money merely as currency is much too narrow for economists. Because checks are
also accepted as payment for purchases, checking account deposits are considered money as
well. An even broader definition of money is often needed, because other items such as savings
deposits can, in effect, function as money if they can be quickly and easily converted into
currency or checking account deposits. As you can see, no single, precise definition of money or
the money supply is possible, even for
economists.

4. TO ELABORATE

To complicate matters further, the word money is frequently used synonymously with wealth and
income.

Wealth - the total collection of pieces of property that serve to store value. Wealth includes not
only money but also other assets such as bonds, common stock, art, land, furniture, cars, and
house.

Income - is a flow of earnings per unit of time. Money, by contrast, is a stock: It is a certain
amount at a given point in time.

The money discussed in this book refers to anything that is generally accepted in payment for
goods and services or in the repayment of debts and is distinct from income and wealth.

Three primary functions of Money:

1. as a medium of exchange
a. it is used to pay for goods and services
b. promotes economic efficiency by minimizing the time spent in exchanging goods
and services

barter economy

- one without money, in which goods and services are exchanged directly for
other goods and services
 transaction cost
- The time spent trying to exchange goods or services
- In a barter economy, transaction costs are high. Why?

2. as a unit of account
a. it is used to measure value in the economy.
b. introduce money into the economy and have all prices quoted in terms of units of
that money, enabling us to quote the price of economics
c. lowers transaction costs in an economy by reducing the number of prices that
need to be considered
3. as a store of value
a. it is a repository of purchasing power over time. A store of value is used to save
purchasing power from the time income is received until the time it is spent.
- Money is not unique as a store of value; any asset—whether money, stocks,
bonds, land, houses, art, or jewelry—can be used to store wealth. If these
assets are a more desirable store of value than money, why do people hold
money at all?

The answer to this question relates to the important economic concept of liquidity.

Liquidity

- the relative ease and speed with which an asset can be converted into a
medium of exchange.
- “Money” is the most liquid asset of all because it is the medium of exchange;
it does not have to be converted into anything else to make purchases. Other
assets involve transaction costs when they are converted into money.

The need for money is so strong that almost every society beyond the most primitive invents it.

5 several criteria For a commodity to function effectively as money

1. It must be easily standardized, making it simple to ascertain its value

2. it must be widely accepted
3. it must be divisible, so that it is easy to “make change”
4. it must be easy to carry
5. it must not deteriorate quickly
Evolution of the Payments System

Payments System

- the method of conducting transactions in the economy.

The payments system has been evolving over centuries, and with it the form of money. At one
point, precious metals such as gold were used as the principal means of payment and were the
main form of money. Later, paper assets such as checks and currency began to be used in the
payments system and viewed as money. Where the payments system is heading has an important
bearing on how money will be defined in the future.

1. Commodity Money
a. An object that clearly has value to everyone is a likely candidate to serve as
money, and a natural choice is a precious metal such as gold or silver. Money
made up of precious metals or another valuable commodity
b. The problem with a payments system based exclusively on precious metals is that
such a form of money is very heavy and is hard to transport from one place to
another. Imagine the holes you’d wear in your pockets if you had to buy things
only with coins! Indeed, for large purchases such as a house, you’d have to rent a
truck to transport the money payment
2. Fiat Money
a. paper currency (pieces of paper that function as a medium of exchange). Initially,
paper currency carried a guarantee that it was convertible into coins or into a fixed
quantity of precious metal
b. paper currency decreed by governments as legal tender (meaning that legally it
must be accepted as payment for debts) but not convertible into coins or precious
metal.

3. Checks

a. an instruction from you to your bank to transfer money from your account to
someone else’s account when she deposits the check. Checks allow transactions to
take place without the need to carry around large amounts of currency.
b. Advantages
1. reduces the transportation costs associated with the payments
system and improves economic efficiency
2. they can be written for any amount up to the balance in the account
3. loss from theft is greatly
 4. reduced and because they provide convenient receipts for
purchases
c. Disadvantages
1. It takes time to get checks from one place to another, a particularly
serious problem if you are paying someone in a different location who
needs to be paid quickly
2. it often takes several business days before a bank will allow you to
make use of the funds from a check you have deposited
3. the paper shuffling required to process checks is costly
4. Electronic Payment
a. banks provide websites at which you just log on, make a few clicks, and thereby
transmit your payment electronically. Not only do you save the cost of the stamp,
but paying bills becomes (almost) a pleasure, requiring little effort.
b. recurring bills can be automatically deducted from your bank account
5. E-Money
a. money that exists only in “electronic” form.
b. Forms of e-money:
1. The first form of e-money was the “debit card” which looks like a
credit card that enable consumers to purchase goods and services by
electronically transferring funds directly from their bank accounts to a
merchant’s account
o example, you can swipe your debit card through the card reader at the
checkout station, press a button, and the amount of your purchases is
deducted from your bank account. Most banks and companies such as
Visa and Master-Card issue debit cards, and your ATM card typically
can function as a debit card.
2. A more advanced form of e-money is the “stored-value card”.
The simplest form of stored-value card is purchased for a preset dollar
amount that the consumer pays up front, like a prepaid phone card. The
more sophisticated stored-value card is known as a “smart card.” It
contains a computer chip that allows it to be loaded with digital cash from
the owner’s bank account whenever needed. In Asian countries, such as
Japan and Korea, cell phones now have a smart card feature that raises the
expression “pay by phone” to a new level. Smart cards can be loaded from
ATM machines, personal computers with a smart card reader, or specially
equipped telephones.
3. A third form of electronic money is often referred to as e-cash,
which is used on the Internet to purchase goods or services. A consumer
gets e-cash by setting up an account with a bank that has links to the
Internet and then has the e-cash transferred to her PC. When she wants to
buy something with e-cash, she surfs to a store on the Web and clicks the
 “buy” option for a particular item, whereupon the e-cash is automatically
transferred from her computer to the merchant’s computer

5. TO EVALUATE

I. Identify which function of money is emphasized:

1. Brooke accepts money in exchange for performing her daily tasks at her office, since she
knows she can use that money to buy goods and services.

2. Tim wants to calculate the relative value of oranges and apples, and therefore checks the
price per pound of each of these goods quoted in currency units.

3. Maria is currently pregnant. She expects her expenditures to increase in the future and
decides to increase the balance in her savings account.

II. Rank the following assets from most liquid to least liquid:
4. Checking account deposits
5. Houses
6. Currency
7. Automobile
8. Savings deposits
9. Common stock

III. Essay
10. Write a reaction paper, not less than 200 words, on the statement, “Money is the root of
all evil.” Utilize the space below for your answer.
.