ROLE OF MONEY IN THE REAL ECONOMY

We learnt the functioning of the real economy of a country without taing into account of
money in it!
Early "tone Age man #egan the u$e of %reciou$ metal$ a$ money
The fir$t $tan&ar&i'e& ingot$ (metal #ar$ lie coin$) a%%eare& aroun& **++ ,C!
Full $tan&ar&i'ation arri-e& with coin$. a%%ro/imately 0++ ,C!
The #arter economy coul& not fulfill the nee&$ of the %eo%le an& a$ a re$ult %eo%le e-ol-e&
money a$ a me&ia of e/change! 1eo%le in ancient Turey A#out *.0++ year$ ago u$e& metal
coin$ a$ money! ,y *.2++ year$ ago. 3ree ha& &e-elo%e& it$ own coinage!
What i$ money4
Money i$ anything that i$ generally acce%te& a$ %ayment for goo&$ an& $er-ice$ an&
re%ayment of &e#t$!
Ty%e$ of money
Commodity money5 gol&. $il-er. co%%er. rice. $alt. %e%%ercorn$. large $tone$. &ecorate&
#elt$. $hell$. alcohol. cigarette$. canna#i$. can&y. #arley. etc!
Re%re$entati-e money5 toen coin$ an& note$
Credit money
Fiat money5 any money who$e -alue i$ &etermine& #y legal mean$. not from any intrin$ic
-alue or guarantee that it can #e con-erte& into gol& or another currency. #ut in$tea& from
a go-ernment6$ or&er (fiat) that it mu$t #e acce%te& a$ a mean$ of %ayment!
E- money5 Electronic money. %la$tic car&$
Money $u%%ly
The money $u%%ly i$ the amount of money within a $%ecific economy a-aila#le for
%urcha$ing goo&$ or $er-ice$! The $u%%ly in the 7" i$ u$ually con$i&ere& a$ four e$calating
categorie$ M+. M8. M*
M" 9 CA"H : NOTE" : ,AN; MONEY
,AN; MONEY9 <EMAN< <E1O"IT" : TIME AN< "A=IN3" ACCO7NT"
(IM1LICIT MONEY)
,AN;IN3 "Y"TEM CAN CREATE MONEY>
?It &e%en&$ on money creation multi%lier5 8@ legal re$er-e ratio
? Ca$h an& note$ are $u%%le& to the economy #y the Central ,an!
<eman& for money $houl& #e eAual to $u%%ly of money in the economy!
Thi$ can #e e/%laine& with IR=IN3 FI"HER"B" THE C7ANTITY THEORY OF
MONEY
Famou$ economic DEAuation of E/changeD 9 M= 9 1T
Thi$ i$ the Auantitati-e theory of money
M i$ the money $u%%ly which inclu&e$ currency an& #an &e%o$it$ a-aila#le to the %u#lic!
= i$ the -elocity of money! E$$entially thi$ $ay$ how Auicly the money $u%%ly i$ turne&
o-er! For e/am%le. if the money $u%%ly i$ M an& monetary tran$action$ totaling M occur$
in 8 month then the money $u%%ly turn$ o-er 8* time$ %er year $o =98*@year
1 i$ the %rice le-el!
T i$ the real -alue of aggregate tran$action$!
"o M= 9 1T mean$ that the total tran$action$ at the current %rice le-el i$ eAual to the total
money $toc multi%lie& #y how often it i$ turne& o-er!
If the money $u%%ly i$ R$!8 #illion an& the -elocity i$ 8*@year $o then R$!8 #illion i$ $%ent 8*
time$ %er year $o a total of R$!8* #illion i$ $%ent!
M= 9 1Y
"u%%ly of money 9 <eman& for money
If money $u%%ly increa$e$ #y 82 E. an& if -elocity remain$ a$ * E an& if real out%ut (3<1)
grow$ at FE #y what %ercent woul& the %rice le-el$ ri$e or fall of thi$ economy4
? %
P
dP
THEN %, 8 %
Y
dY
2%, %
V
dV
15%, %
M
dM
= = =
%
Y
dY
%
P
dP
%
V
dV
%
M
dM
+ = +
82E : *E 9 4 : F E
The %rice le-el$ will go u% #y GE in thi$ economy!
Appendix
Y = X.W
Using Chain rule:
) 1 ( . dW
dW
dY
dX
dX
dY
dY + =
Where :
: ) 1 ( , , equation to these ng Substituti X
dW
dY
Similarly W
dX
dY
then XW Y if = = =
) 2 ( . dW X dX W dY + =
We can divide b!h "ide" # !he e$%a!in (2) b& Y
) ' ( dW
Y
X
dX
Y
W
Y
dY
+ =
) ' ( , , to these ng Substituti
W
Y
X and
X
Y
W then XW Y If = = =
) ( ( dW
Y
W
Y
dX
Y
X
Y
Y
dY
+ =
W
dW
X
dX
Y
dY
dW
Y W
Y
dX
Y X
Y
means This
+ =
+ = ) 5 (
1 1
:
What will ha%%en to the intere$t rate (co$t of ca%ital) in thi$ economy4
Let u$ $ee the &eman& for money an& $u%%ly of money from ;eyne$ean %oint of -iew5
<eman& for money5
Wealth i$ e%t #y %eo%le an& firm$ in &ifferent form$5 1hy$ical a$$et$ (lan&. #uil&ing$.
eAui%ment$. $toc$) : income #aring financial a$$et$ ($a-ing$. fi/e& account$. $hare$.
$toc$ an& #on&$) : liAui&ity form$ (ca$h an& note$)!
When wealth i$ e%t in liAui&ity form$ it $carifie$ $ome return$. intere$t or ca%ital
gain$). There i$ alway$ an o%%ortunity co$t of hol&ing money in liAui&ity form$!
Why %eo%le $acrifice $uch gain$4
8! Tran$action moti-e$
*! 1recautionary moti-e$
H! "%eculati-e moti-e$
Tran$action moti-e$
In&i-i&ual$ an& firm$ lie to hol& money #ecau$e of the con-enience it yiel&$ in the %lanne&
%urcha$e of goo&$ an& $er-ice$! Thi$. to ;eyne$ i$ &etermine& #y the le-el of income an&
in$titutional factor$!
The $tan&ar& tran$action &eman&5 m
t
9 g (i. Y) (;eyne$? ,aumol a%%roach)
(*) 1recautionary &eman& for money
The re$ult of %ro-i&ing for contingencie$ an& unfore$een o%%ortunitie$ of a&-antageou$
%urcha$e$ (un%lanne& e/%en&iture)
i
m
t
Y8 Y* YH
(H) "%eculati-e &eman&
The %o$$i#ility that e/%ectation$ of future %rice$ an& intere$t rate$ coul& affect the &eman&
for money
m
&
9 Tran$action &eman& : %recautionary &eman& : $%eculati-e &eman&
Let u$ a$$ume money $u%%ly i$ a $toc $u%%lie& #y the financial authority of the country!
Then the eAuili#rium in the money maret coul& #e $een from the following &iagram!
i
m
t
m
t 9 g( i. Y)
i
m
$%
i
M
$%9 h( i)
: 9
m
&
Y9Y8
Y9Y*
Y9YH
Y8 Y* YH
i
m
$%
i
M
$%9 h( i)
: 9
m
&
Y9Y8
Y9Y*
Y9YH
r
8
r
*
r
H
m
$
m
$
When income goe$ u% an& &eman&$ for money goe$ u% the intere$t rate ri$e$!