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ECON 4100Monetary Economics

William D. Lastrapes

Fall 2008

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Money

Specialization is necessary for high productivity, high

standards of living.

Trade and exchange are necessary for specialization.

Money reduces costs of and facilitates exchange.

So without money, low standard of living for all.

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Money

The study of money is the study of how people

trade, the mechanics of the payments system.

Such mechanics are typically ignored in micromodels of voluntary exchange and efficient

allocation of resources.

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Voluntary exchange without money

Barter: exchange of goods for direct consumption.

(Double) coincidence of wants: for mutuallybeneficial trade to occur under barter, a seller

must find a buyer who wants what he or she has,

and has what he or she wants.

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Voluntary exchange without money

The butcher has more meat in his shop than he

himself can consume, and the brewer and the

baker would each of them be willing to purchasea part of it. But they have nothing to offer in

exchange, except the different productions of

their respective trades, and the butcher is already

provided with all the bread and beer which he hasimmediate occasion for. No exchange can, in this

case be made between them. -- Adam Smith

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Solutions to the coincidence of wants

Central market (with trading posts). The key here

is providing information.

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Indirect barter: accept some goods for trade, not

consumption.

A stylized example:

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Preference Endowment First trade Final trade

Butcher Beer Meat Bread (from

baker)

Beer (from brewer)

Brewer Bread Beer Bread (from

butcher)

Baker Meat Bread Meat (from

butcher)

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Money will evolve from indirect barter as a single goodbecomes most saleable.

In order to avoid the inconveniency of such situations [no

possible exchange], every prudent man in every periodof society, after the first establishment of the division oflabour, must naturally have endeavoured to manage hisaffairs in such a manner as to have at all times by him,

besides the peculiar produce of his own industry, acertain quantity of some one commodity or other, suchas he imagined few people would be likely to refuse inexchange for the produce of their industry. -- Smith

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Claim on labor

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To Kill a Mockingbird

Good morning, Mr. Finch. I didn't wantto bother you none. I brung you thesehere hickory nuts as part of myentailment. Well, I thank you.

The collards we had last week were

delicious. Scout, I think maybe, uh, next time Mr.Cunningham comes, you better not callme. I think it embarrasses him to bethanked.

Why does he bring you all this stuff?

He's paying me for some legal work Idid for him.

Why does he pay you like this? That's the only way he can. He has no

money.

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Modern barter

Modern day barter systems: the internet can be

used to provide information about exchange,

which can promote direct (i.e. barter) exchange.An example:

http://www.merchantsbarter.com/
http://www.merchantsbarter.com/http://www.merchantsbarter.com/

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Functions of money

Money is an asset or store of value that facilitates

exchange. Money is neither income, nor wealth.

Two basic functions of money:

medium of exchangegenerally accepted means

of payment medium or unit of account, or a standard of

value.

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Functions of money

Relative prices

With n goods: n(n-1)/2 relative prices.

n= 5 10; n = 100 4950 relative prices.Under barter, must keep track of all.

With unit of account, only keep track of n-1 prices,and easily compute relative prices. Example:

relative price of apples in terms of oranges is theunit of account price of apples divided by unit ofaccount price of oranges.

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Functions of money

Logically, the medium of exchange function and

unit of account function need not be served by

the same commodity. For example, gold might bemedium of exchange, dollars might be unit of

account.

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Comments

Menger (1871): moneyevolves spontaneously

Most saleable goods: scarce,durable, portable, divisible,

and homogeneous

Cattle one of the first media

of exchange and media of

account; but metals (gold and

silver most commonhistorically)

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Modern money

Paper currency

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Modern money

Paper currency

Checkable deposits at

banks (checking

accounts)

Stored-value cards

Local currencieshttp://www.berkshares.org/

Pay pal?
http://www.berkshares.org/http://www.berkshares.org/http://www.berkshares.org/http://www.berkshares.org/

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Alternatives to money

Credit

Liquid assets Gold and silver?

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Purchasing power of money and

inflation

Purchasing power of money: value in exchange

for other goods: how much a monetary unit canbuy.

Price level: the reciprocal of the purchasingpower of money; the money price of the average

good. Inflation rate: rate of change of price level over

time

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US Price level (CPI)

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US Inflation (CPI)

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Recent US inflation

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Purchasing power of money and

inflation

Hyperinflation: extreme inflation (say greater

than 50% per month). At this rate, $1 item on

Jan. 1 would cost $130 on Dec. 31. German hyperinflation: inflation rate was 322%

per month from August 1922 to November 1923.

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German wholesale price index

Index mon. rate

12/1914 125

12/1921 3,490 4.3%12/1922 147,480 36.6%

12/1923 126,160,000,000,000 455%

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Inflation

Inflation occurs when the quantity of money grows faster than thedemand to hold it. If there is too much money, people try to spendit on goods and services, driving prices up.

Too much money chasing too few goods.

Inflation is always and everywhere a monetary phenomenon.

Hyperinflations occur when money supply growth far exceedsmoney demand growth, as in Post World War I Germany. Such

hyperinflation can only happen with fiat money when money ischeap to produce and there is no anchor for its quantity.

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Measuring the quantity of money

M1 = Currency held outside of banks + checkabledeposits issued by financial institutions + travelers

checks M2 = M1 + plus savings deposits (including moneymarket deposit accounts) and small-denomination (lessthan $100,000) time deposits issued by financialinstitutions; and shares in retail money market mutual

funds (funds with initial investments of less than$50,000), net of retirement accounts.

MZM = M2 + institutional money market mutualfundssmall denomination time deposits.

M1 money stock

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M1 money stock

M1 money stock

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M1 money stock

M2 money stock

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M2 money stock

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Real money balances

M = nominal stock of money (in unit of account)

P = price level

M/P = real money stock; the quantity of money in terms ofits purchasing power, what it can buy.

An example: the real value of $100, if bread is $2 a loaf, is50 loaves of bread.

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A shopping time model of money

Households consume leisure and other stuff

They can shop or consume leisure. Opportunity cost of shopping is leisure.

Shopping time can be reduced by incurring

transactions costs. Optimal shopping time minimizes total costs of

exchange.

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Costs

Shopping

Time

Waiting costs

Transactions costs

Total costs

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Costs

Shopping

Time

Waiting costs

Transactions costs

with barter

Transactions costs

With money

4100 part 1

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