Economics
Table of Contents
ECONOMICS................................................................................................................................. 1
CHAPTER 7 MONEY ................................................................................................................................. 2
7.1 The functions of money ............................................................................................................ 2
7.2 Money supply .................................................................................................................... 3
7.3 Demand for money ........................................................................................................... 6
7.4 Monetary policy ....................................................................................................................... 7
Glossary .......................................................................................................................................... 9
CHAPTER 8 MONEY AND CAPITAL MARKETS ............................................................................................... 10
8.1 Functions and classification of the money and capital markets ............................................ 10
8.2 The money market .......................................................................................................... 10
8.3 The capital market .......................................................................................................... 11
8.4 The term structure of interest rates ................................................................................ 14
8.5 Interest rate risk .............................................................................................................. 15
Glossary ........................................................................................................................................ 17
, Chapter 7 Money
7.1 The functions of money
If the division of labour increases in an economy, people will start focussing more on the production
of a particular product for the market. The more the division of labour increases in an economy, the
more important the role of money becomes. Time gained by the use of money can be used to
produce more products. Trading with money, therefore leads to an increase of labour productivity.
Functions of money:
1. Means of exchange: the possibility of dividing a transaction into two parts that money
offers (to exchange goods/services).
2. Means of evaluation (account): the possibility to measure the value of goods/services that
money offers.
3. Means of storing wealth: the possibility of holding capital that money offers.
7.1.1 Money as a mean of exchange
Has two great advantages :
1. The exchange can be separated into two parts.
2. Two transactions do not have to take place at the same time.
In a barter exchange a baker will have to find someone who wants to exchange for example meat for
his bread. Costs to look for a suitable consumer are high. In a money exchange he can sell bread to
whoever wants it in return for money and use this money to buy meat.
A high level of inflation affects the exchange function of money, because it makes it more difficult to
split a transaction into two parts. The purchasing power of money decreases when inflation rises.
7.1.2 Money as a means of evaluation
Goods have to be given a value for purposes that have nothing to do with the exchange situation,
but for example to make up a balance sheet. Using money as a means of evaluation has the effect of
dramatically limiting the number of prices in an economy.
With the number of prices, the values of the items can be compared to each other because they are
all expressed in terms of an amount of money, which will reduce transaction costs. Compared to a
barter economy, because every item has to be expressed in terms of all other goods.
Using money as a means of evaluation becomes problematic with a high inflation. In countries like
this, prices are an indication of the real value of goods for only a very short time.
7.1.3 Money as a means of storing wealth
By saving, households build up assets during the course of time. They can hang on these assets in
the form of real estate, shares, bonds, savings accounts or in the form of liquid assets (coins,
banknotes or a demand deposits at the bank).
Hoarded money: cash that is kept as an asset.
In a country with a high inflation rate, using money as a means of storing wealth is ineffective.
Households that keep part of their assets in the form of cash will notice that their purchasing power
of their cash is decreasing rapidly.
Table of Contents
ECONOMICS................................................................................................................................. 1
CHAPTER 7 MONEY ................................................................................................................................. 2
7.1 The functions of money ............................................................................................................ 2
7.2 Money supply .................................................................................................................... 3
7.3 Demand for money ........................................................................................................... 6
7.4 Monetary policy ....................................................................................................................... 7
Glossary .......................................................................................................................................... 9
CHAPTER 8 MONEY AND CAPITAL MARKETS ............................................................................................... 10
8.1 Functions and classification of the money and capital markets ............................................ 10
8.2 The money market .......................................................................................................... 10
8.3 The capital market .......................................................................................................... 11
8.4 The term structure of interest rates ................................................................................ 14
8.5 Interest rate risk .............................................................................................................. 15
Glossary ........................................................................................................................................ 17
, Chapter 7 Money
7.1 The functions of money
If the division of labour increases in an economy, people will start focussing more on the production
of a particular product for the market. The more the division of labour increases in an economy, the
more important the role of money becomes. Time gained by the use of money can be used to
produce more products. Trading with money, therefore leads to an increase of labour productivity.
Functions of money:
1. Means of exchange: the possibility of dividing a transaction into two parts that money
offers (to exchange goods/services).
2. Means of evaluation (account): the possibility to measure the value of goods/services that
money offers.
3. Means of storing wealth: the possibility of holding capital that money offers.
7.1.1 Money as a mean of exchange
Has two great advantages :
1. The exchange can be separated into two parts.
2. Two transactions do not have to take place at the same time.
In a barter exchange a baker will have to find someone who wants to exchange for example meat for
his bread. Costs to look for a suitable consumer are high. In a money exchange he can sell bread to
whoever wants it in return for money and use this money to buy meat.
A high level of inflation affects the exchange function of money, because it makes it more difficult to
split a transaction into two parts. The purchasing power of money decreases when inflation rises.
7.1.2 Money as a means of evaluation
Goods have to be given a value for purposes that have nothing to do with the exchange situation,
but for example to make up a balance sheet. Using money as a means of evaluation has the effect of
dramatically limiting the number of prices in an economy.
With the number of prices, the values of the items can be compared to each other because they are
all expressed in terms of an amount of money, which will reduce transaction costs. Compared to a
barter economy, because every item has to be expressed in terms of all other goods.
Using money as a means of evaluation becomes problematic with a high inflation. In countries like
this, prices are an indication of the real value of goods for only a very short time.
7.1.3 Money as a means of storing wealth
By saving, households build up assets during the course of time. They can hang on these assets in
the form of real estate, shares, bonds, savings accounts or in the form of liquid assets (coins,
banknotes or a demand deposits at the bank).
Hoarded money: cash that is kept as an asset.
In a country with a high inflation rate, using money as a means of storing wealth is ineffective.
Households that keep part of their assets in the form of cash will notice that their purchasing power
of their cash is decreasing rapidly.
