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Money and Price Level. Paper Money. Does Paper Money have any intrinsic value? What is money then? Why is it important? If there was no money then we would have to barter For barter to work – trade is said to require the double of coincidence of wants. . The history of money.
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Paper Money • Does Paper Money have any intrinsic value? • What is money then? • Why is it important? • If there was no money then we would have to barter • For barter to work – trade is said to require the double of coincidence of wants.
The history of money • Mesopotamian civilization developed a large scale economy based on “Commodity money” • Many other cultures also developed commodity money • Tobacco in America, Shells in India, Spices in Europe, Alcohol in New South Wales • If you were in prison, what would be good forms of money to smuggle in.
3 important functions ofmoney • Medium of exchange • Anything that facilitates trade by being generally accepted by all parties in payment for goods and services. • Unit of Account • A common unit for the measuring the value of every good and service. • Store of Value • Anything that retains its purchasing power over time.
The characteristics of Commodity money • Durable • Portable • Divisible • Uniform Quality • Gresham’s law – people tend to horde good money and trade away the rest. • Low opportunity cost • Value of money should not fluctuate erratically.
What is commodity money • Money that takes the form of a commodity with intrinsic value • Intrinsic means that the item would have value even if it was not used as money. • Money without intrinsic value is known as Fiat Money
Too much money vs Too little money • The fall of the Soviet Union • The ruble experienced hyper inflation. • Value of the ruble fell dramatically • Russians demanded other hard currency • Sanctions against Panama • The Panamanians depended on the dollar • The US did not permit them to trade. • People started hording dollars. • Started taking money out of banks. • Finally people resorted to barter • Panama’s GDP as a result fell 30% in 1988
Why is inflation Unpopular • Higher inflation means you have to spend more? • When viewed from the income side – • Higher inflation means • You get paid more • You get more for your factors of production. • UNLESS PRODUCTIVITY INCREASES HIGHER WAGES MEAN HIGHER PRICES • Who are hurt the most because of inflation • Individuals whose incomes are fixed in nominal terms – Pensions, EPF
Factors of Inflation • Increase in the money supply • Decrease in the demand for money • Decrease in aggregate supply of goods and services. • Increase in aggregate demand for goods and services.
Cost push inflation • Basically means that prices have been pushed up due to the increase in the 4 factors of production. • Higher production costs • Companies cannot maintain profit margins • Costs are passed on to the consumer • Prices rise • Rising Prices mean inflation has increased.
Demand pull inflation • Occurs when there is an increase in aggregate demand • When the four sectors of the economy increase their consumption • Households, Government, Firms, Foreign buyers • They bid prices up • Increased prices = inflation.
Is inflation bad? • Practically every economist will tell you that • a little bit of inflation is a good thing • a lot of inflation is a bad thing • A little bit of inflation is like a tax on idle money. It prompts people to get their money out of the mattress (or low interest accounts) and put it to work on investments. • A lot of inflation prompts people drives money out of economy-driving investments and into inflation-proofing investments (gold which does nothing for the economy). • Deflation makes idle money profitable so no one, not the Fed or economists, wants to see deflation. If deflation was a risk today, you would see the Fed trying to fight it.
