AP Economics Unit 4

Money 

Uses of money 

. Medium of exchange
Bar and trade
. Unit of account
Establishes economic value.
. Store of value
Money holds its value over a period of time where as products may not.

                              Types of Money
A. Commodity Money
Gets its value from the type of material form which its made Ex. Gold and silver coins
B.  Representative Money
Paper money backed by somethings tangible that gives it value
C. Fiat Money
Money because the government says so

1. Characteristics of money 

A. Divisible
Can be broken down in different ways
B. Portable
Can carry them anywhere
C. Uniform
A dollar is a dollar anywhere you go
D. Acceptable
E. Scarce
F. Durable

1. Money supply 

A. M1 money
75% of money comes from M1 money because it's easy to change (liquidity)

1. Cash and coins. 
2. Currency, Checkable deposit and demand deposit. 
3. Travelers checks. 

B. M2 money
Consist of M1 money, savings account and deposits held by banks outside of the US.
C. M3 money
M2 money and certificates of deposits also known as CDs: money you keep on the back for an amount of time.


TIME VALUE OF MONEY
Let V = future value of $
P = present value of $
R= real value of $ ( nominal - inflation ) expressed as a decimal
N= years
K= number of times interest is created per year

Money demand Money supply
Money supply line vertical
Money demand line downward sloping

Demand for money had an inverse relationship between nominal interest rates and the quantity of money demanded.

1. What happens to quantity demanded of money when Interest rates increase 

Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.

1. What happens to quantity demand when Interest rate decrease 

Quantity demanded increase. There is no incentive to convert cash into interest earning assets.

What happens if price level decrease
Money demand shift to the right.

Money demand shifters.

1. Changed in price level 
2. Changes in income. 
3. Changes in taxation that affects investment. 

Increasing the money supply - increasing shifting to the right.

If the FED increased the money supply, temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall to 2%.

How does this affect AD
Increase money supply ➡️decrease interest rate ➡️ increase investment ➡️ increase AD

DECREASING THE MONEY SUPPLY
decrease money supply ➡️increase interest rate ➡️ decrease investment ➡️decrease AD

      FINANCIAL ASSETS vs FINANCIAL LIABILITY.
Financial Asset - something you own
Financial liability - something you owe

Interest rate
The cost of borrowing money.

Stock and Bonds.
Stocks - is a share of company
Bonds - you borrow money to the government they will pay you back

What banks do ?
A bank is a financial intermediary
Uses liquid assets to finance the government the investments of borrowers   
Process is known as fractional reserve banking.

• A system in which depository institutions hold liquid assets less than the amount of deposits 
• Can take the form of 

1. Currency in bank vaults 
2. Bank Reserves- deposits held at the Federal Reserve. 

T- Account ( Balance Sheet)




Rea ever requirement

1. The fed requires banks to always have some money readily available to meet consumers demand for cash. 
2. The amount set by fed is required reserve ratio. 
3. The required reserve ratio is the percent of demand deposits. ( checking account balances)that must not be loaned out. 
4. Typically the required reserve ratio = 10%. 

Three types of Multiple deposit expansion question.
Type 1: calculate the init ail change in excess reserves
Type 2: calculate the change in the money supply.
Type 3: calculate the change in the money supply

• Type 2 and 3 will have the same result.  

1. The reserve Requirements 

Only a small percent of your bank deposit is in the safe. The rest of your money had been loaned out. This is called fractional reserve banking.

The FED sets the amount that banks must hold

The reserve requirement is the percent of deposits that banks must hold in reserve and not loan out

When FED increases the money supply it increases the amount of money held in bank deposits.

1. If there is a recession the FRD should decrease the reserve ratio. 

• banks hold less money and have more excess reserves 
• Banks create more money by loaning out excess
• Money supply increases m, interest rates fall, ad goes down.

1. If there is inflation the FED should increase reserve ratio. 

• banks hold more money and have less excess reserves 
• Banks create less money 
• Money supply decreases, interest rates up, AD. Down. 

1. Discount rate 

The discount Rate is the interest rate that the FED charges commercial banks.
Ex. If Bank of America needs 10m they borrow it from the U.S treasury but they must pay back with interest

To increase the money supply, the FED should Decrease the discount rate (easy money policy)

To decrease the Money supply the FRD should Increase the discount Rate ( Tight Money Policy).

1. Open market operations 

The FED sell government bonds (securities)
This is the most important and widely used monetary policy.

To increase the Money supply, the FED should BUY government securities

To decrease the money supply, The FED should sell government securities.

Federal Fund Rate
These is where FDIC member bank loan each other over night funds.

Prime Rate
It's the interest rate that banks give to their most credit worthy customers.




Final Notes
When a customer deposits cash or withdrawals cash from their demand deposit acct. it has no effect on money supply.

Single Bank

• loan money from excess reserves. 

Banking System

• ER X multiplier ( total money supply)

It only changes

1. The composition of the money 
2. Excess reserves 
3. Required reserves