Unit IV

1. All About Money
Christa Washington
AP Economics
April 14,2013
7th period

2. MONEY
• Uses of money:
• Medium of Exchange: where you’re able to buy
goods/services(EX. Barter, trade)
• Unit of Account: est. economy worth
• Store of Value: money holds its value over a period of
time
• Types of Money:
• Commodity Money: swapping goods
• Representative Money: EX. IOU
• Fiat Money: money because gov’t says

3. MONEY (CONT’D.)
• Characteristics of Money:
– Durability: how durable is $
– Portability: $ is portable
– Divisibility: $ can be divided down
– Uniformity: U.S. $ will be uniformed
– Scarcity: $2 bills
– Acceptability: $ is acceptable everywhere
• Money Supply:
– M1 Money: consist of:
• Currency in circulation(paper $/coins)
• Checkable deposit(demand deposit)
• Traveler’s check
– M2 Money: consist of:
• M1 money
• Savings account
• Money market account
• Deposits held by banks outside the U.S.

5. How Banks Work
ASSETS LIABILITIES + EQUITY
-Reserves: - Req. reserve(rr): % required -Demand deposits ($ put in bank)
by Fed to keep on hand to meet demand -Timed Deposits (CD’s)
-Excess Reserves (er)- % -Loans from: FED Reserves & other banks
reserved over/above amount needed to -Shareholders Equity: to set up a bank,
satisfy the minimum Reserve Ration set you must invest your own money in it to
by FED have a stake in the bank’s success/failure
-Loans to firms, consumers, and other
banks
-Loans given to gov’t= treasury securities
-Bank property- if bank fails, you could
liquidate building/property

6. Reserve Requirement
• Amount, set by FED, is the required reserve
ratio
• Typically the required reserve ratio= 10%

7. EXAMPLE
• THE RESERVE RATIO IS 5%. YOU DEPOSIT
$1000 INTO A BANK. HOW MUCH IS THE
BANK REQUIRED TO ADD TO ITS RESERVE?
– .05 x 1000= $50 RES. RATIO
• HOW MUCH $ CAN THE BANK NOW LOAN
OUT?
– 1000(DEPOSITED)- 50(RES. RATIO)= $950 LOAN

9. Significance of a Fractional Reserve
1. Banks can create $ by lending more
2. Required Reserve doesn’t prevent bank
panics because banks must keep their req.
res.
3. Reserve req. gives FED control over how
much $ banks give

10. Functions of FED
1. Control the nation’s money supply through
monetary policy: - adjust interest rate
- Circulation of currency
2. Issue paper currency
3. Serve as a “clearing house” for checks
4. Regulating banking activity
5. Serve as a bank for banks

11. Balance Sheet
• Statement of assets and claims summarizing
final position of a firm or bank at some point
in time
• *MUST BE BALANCED AT ALL TIMES!!
ASSETS LIABILITIES + NET WORTH
WHAT YOU OWN WHAT YOU OWE

13. Required Reserve Ratio
• The % of demand deposits that must be stored as
vault cash or kept on reserve as Fed Funds in the
bank’s acct. w/ FED Res.
• Req. Res. Ratio determines $ multiplier( 1/rr)
• res. Ratio rate of $ creation in banking sys &
expansionary
• res. Ratio rate of $ creation in banking sys &
contractionary
• Changing req. res. Ratio is least used tool of
monetary policy & is usually held constant @ 10%

14. The Money Multiplier
• Shows us the impact of a change in demand
deposits on loans and eventually $ supply
• Indicates total # of $ created in the banking
sys by each $1 addition to monetary base
• To calculate:
– Money Multiplier= 1/ res.ratio

15. 4 Types of Multiple Deposit Expansion
Questions:
• Type 1: Calculate the initial ∆ in excess
reserves.
• Type 2: Calculate ∆ in loans in banking system
• Type 3: Calculate ∆ in $ supply
• Type 4: Calculate ∆ in demand deposits

17. FORMULAS
• Req. Res= amt of deposit x req. res. Ratio
• Excess Res= total res.- req. res.
• Max amt a single bank can loan= the ∆ in er caused by
a deposit
• Money Multiplier= 1/ Req. Res. Ratio
• Total change in loans= amt single bank can lend x
money multiplier
• Total ∆ in $ Supply= total ∆ in loans + $ amt of FED
Actions
• Total ∆ in demand deposits= total ∆ in loans + any cash
deposited

18. Monetary vs. Fiscal
FISCAL POLICY MONETARY POLICY
• Congress: • The FED:
•TAX •OMO(open market operations): you
Or could buy/sell bonds
• SPEND •Reserve Requirement
•Discount Rate: interest rate charged
by FED for overnight loans to
commercial banks
•Federal Funds Rate: interest rate
charged by one commercial bank for
overnight loans to another
commercial bank
*The FED has several tools to manage the $ supply by manipulating the er held by
banks, a practice known as monetary policy

19. Monetary vs. Fiscal (cont’d.)
MONETARY POLICY OPTION EXPANSIONARY CONTRACTIONARY
“easy money” “tight money”
OPEN MARKET OPERATIONS Buy bonds Sell bonds
REQUIRED RESERVE Required Reserve Ratio Required Reserve Ratio
DISCOUNT RATE Discount Rate Discount Rate
FEDERAL FUNDS RATE Federal Funds Rate Federal Funds Rate

21. Loanable Funds Market
• Market where savers/borrowers exchange funds
at real rate of interest (r%)
• Demand for loanable funds, or borrowing comes
from households, firms, gov’t and foreign sector-
also the supply of bonds
• Supply of loanable funds, or savings comes from
households, firms, gov’t & foreign sector- also
the demand for bonds
• PRIME RATE: interest rate that banks charge to
their most praise worthy customers

22. ∆ in the Demand for Loanable Funds
• Remember that demand for LF= borrowing
• More borrowing= more demand for LF
• Less borrowing= less demand for LF
• EXAMPLE:
– Gov’t deficit spending= more borrowing= more
demand for LF
– Less investment demand= less borrowing= less
demand for LF

23. ∆ in Supply of Loanable Funds
• Remember supply of LF= saving
• More saving= more supply of LF
• Less saving= less supply of LF
• EXAMPLE:
– Gov’t budget surplus= more saving= more supply
LF
– Decrease in consumers’ MPS= less saving= less
supply of LF

24. Countercyclical Policies