THE FUNCTIONS OF MONEY:
There are 3 functions of money that distinguish money from
other assets in economy which are discussed in following;
1. MEDIAN OF EXCHANGE: Money is said to be the median of
exchange because it can be used to any good or service.
2. UNIT OF ACCOUNT: Money is measure of account or value
because value of tells us how much a good or service is more
worthy than other. as example a ten rupee pen is 5 times more
worthy than a 2 rupee
pencil or a 10k mobile and 10k pc are equal worthy.
3. STORE OF VALUE: By simply storing the money a man can
store his purchasing power to buy goods and services in future.
KINDS OF MONEY:
1. BARTER MONEY: As discussed earlier.
2. COMMODITY MONEY: When money takes the form of
commodity and has intrinsic value is called commodity money
or we can say that when a particular good is exchanged for the
other particular
good.
3. FIAT MONEY: Money without intrinsic value is called fiat that
is actually an order or decree by the government and those
easily acceptable in territory. The paper money that is being
used nowadays is a Fiat Money.
OPEN MARKET OPERATIONS: The sales and purchase of bonds.
When a central bank wants to increase the money supply they
prints paper bills and buy the public bonds and when they want
to decrease the money supply they prints the bonds and sell
them to public so the money is increased and decreased in
market respectively.
RESERVES: The amount of money from deposits that a bank
holds in its vault is called reserve.
RESERVE RATIO: The percentage ratio of total deposits a bank
holds is called reserve ratio.
RESERVE REQUIRMENTS: The minimum amount of reserve that
a bank must hold in vault.
EXCESS RESERVE: The amount more the minimum legal reserve
INFLATION: Overall increase in prices level such as CPI and GDP
Deflator is called inflation. When a central bank prints more
money the inflation rises. They do this to pay their spending.
HYPERINFLATION: An extraordinary inflation is called
hyperinflation. Hyperinflations usually defined as 50% per
month. Just when a central bank prints too much money
papers.
DEFLATION: Overall decrease in prices level is called deflation.
MONETRY EQUILIBRIUM: The balance between the money
supply and money demand.
MONETARY INJECTION: When a central bank prints more paper
bills and supply them to economy by open market operations
or giving away to public is called monetary injection.
QUANTITY THEORY OF MONEY: The money supply determines
the value of money which is increased by decrease in money
supply and vice versa.
CLASSICAL DICHOTOMY & MONETARY
NEUTRALITY: The injection of money in economy affect the
Real Variables (The variables that are measured in monetary
units e.g. wages and price level) but it doesn’t affect the Real
Variables (The variables that are measured in physical units e.g.
no of tons of gold are measured in Relative Prices means
comparison of prices of two different goods and services). Thus
this separation of economy in to two variables is called Classical
Dichotomy and the zero impact of monetary injection on real
variables is called Monetary Neutrality. Because the excess of
money does change in prices but doesn’t affect the
productivity.
VELOCITY OF MONEY: The speed with a paper bill travels from
person to person.
V=(p×y)/M. (i)
Here V is velocity that is equal to (price level nominal
GDP)/money paper bills.
INFLATION TAX: When a government increases its revenue by
printing more money so the money already in hands of people
becomes less valuable so they have to pay extra to buy
something so is like a tax that is called inflation tax.
. FISHER EFFECT: When nominal interest rate is adjusted with
inflation rate that is called fisher effect. According to this
nominal interest always increases when the inflation rises but
real interest remains
same all time.
OPEN ECONOMY & CLOSED ECONOMY: Economies that
interact with other country economies are called open
economies and vice versa. Till now everything was discussed in
details with the aspects of closed economy. Now the only open
economy will be discussed.
ASPECTS OF OPEN ECONOMY:
The open economy has been divided in two parts;
• Import & exports of sales and goods.
• Import & exports of capital such as bond and stocks.
1. IMPORTS/EXPORTS OF GOODS:
IMPORT: When a country purchase goods & goods from
abroad.
EXPORT: When a country produce goods & services and sells
them to the abroad.
NET EXPORTS/BALANCE Trade =EXPORTS – IMPORTS
Net have following three aspects;
• If net export equation is more than zero that it is said to be
trade surplus.
• If the net export equation is less than zero than it is said to
be trade deficit.
• If the net export equation is equals to zero than it said to
balanced trade.
NOTE: Here are some important factors that impact on net
exports;
IMPORT/EXPORTS OF CAPITAL ASSETS:
NET CAPITAL OUTFLOW/NET FOREIGN INVESMENT:
=foreign assets purchase by domestic people – domestic
assets purchase by foreigners.
It has two aspects;
• When equation is positive it is said to be capital flowing out to
country.
• Otherwise it is said to be capital flowing into country.
FOREIGN DIRECT INVESMENT: When locals start their own
business in abroad and they control investment.
FOREIGN PORTFOLIO INVESMENT: When locals buy stocks and
bonds in abroad and they get interest on their share but in this
case they can’t control the investments of those companies.
STAGFLATION (BAD CONDITIONS):
1. Suppose bad conditions start and firms cost of production
increases.
2. Firms would like to reduce their production because they are
paying more.
3. In this case aggregate supply curve would shift from AS1 to
AS2.
4. Short run economy equilibrium would move from point A to
B.
5. Natural production rate would move from Y1 to Y2
