What Is Money?

Front 1

You and a group of friends have an everyday conversation. You hear the following statements:

Ben: "I don't have that much money in my pocket."
Kaitlin: "I want to earn a business degree because then I'll earn a lot of money each year."
Mei: "I need to get some money from the ATM to buy coffee."
Shani: "I want to buy the textbook, but it costs a lot of money."
Charlie: "My uncle has a lot of money in his investment portfolio."

Which of your friends is misusing the word "money," according to the economists' definition?

Back 1

Kaitlin and Charlie

The economists' definition of money includes any object that is accepted as a means of payment. When Kaitlin uses the word money, she means income. Even if she has a high annual income, she might hold very little of her wealth in such forms as currency or demand deposits that she could use as a means of payment.

Charlie is using "money" when he means "wealth." Although both money and wealth are stock variables, they refer to different things. Money is used as a means of payment. Wealth refers to the value of an individual's total assets, including money. The value of Charlie's uncle's portfolio refers to his uncle's wealth, not his money.

Front 2

In the economy of Etania, the people use a rare type of shell as money.

A young woman named Chenoa earns 100 shells per month. These 100 shells are _______. Each month, she hides 20 of her shells in a safe place so that she can use them in the future. When she does this, Chenoa is using these shells as ________. She spends the remaining 80 shells on food and clothing.

Back 2

Income, a store of value

When we say that Chenoa earns 100 shells each month, this refers to her income. (Remember that income is a flow variable, measured over a period.) Each month, when she places 20 shells in a safe place for later use, Chenoa uses the shells as a store of value. This allows Chenoa to build up her stock of wealth for future use.

Front 3

In the economy of Etania, the people use a rare type of shell as money.

Chenoa sees that a pound of maize costs 20 shells and decides that this is too expensive. In this case, Chenoa uses money as a ________. She decides to purchase vegetables instead. Chenoa spends 40 shells on five pounds of vegetables. When she exchanges her shells for the vegetables, Chenoa uses shells as ________.

Back 3

Unit of account, a medium of exchange

A unit of account lets someone quote prices or understand value. When Chenoa sees that maize costs 20 shells per pound, she uses shells as a unit of account and decides that maize is not worth this much. When she spends 40 shells in exchange for vegetables, Chenoa uses money as a medium of exchange. She exchanges her shells for vegetables.

Front 4

In the economy of Etania, the people use a rare type of shell as money.

In addition to using them as money, Chenoa strings some of her shells into necklaces that she wears as decoration. From this, you can conclude that in Etania, shells are ________.

Back 4

Commodity money

Shells are commodity money because the shells have an intrinsic value that does not depend on whether they are used as money.

Front 5

In the economy of Etania, changes in climate cause more of the previously rare shells to wash up onto the shore. The number of goods produced in Etania remains the same.

The increased number of shells will cause ________ in the purchasing power of money.

Back 5

A decrease

The increase in the supply of shells causes a decrease in their value. Because production in Etania has not changed, this means more money is used to purchase the same goods, causing an increase in prices.

Front 6

In the economy of Etania, changes in climate cause more of the previously rare shells to wash up onto the shore. The number of goods produced in Etania remains the same.

Prior to the change in climate, Chenoa spent 40 shells to buy five pounds of vegetables. The price of vegetables before the climate change was ________.

Back 6

8 shells per pound

Prior to the change in climate, Chenoa spent 40 shells for five pounds of vegetables, or

Price per Pound of Vegetables = Number of Shells / Pounds of Vegetables
Price per Pound of Vegetables = 40 Shells / 5 Pounds of Vegetables
Price per Pound of Vegetables = 8 Shells per Pound of Vegetables

Front 7

In the economy of Etania, changes in climate cause more of the previously rare shells to wash up onto the shore. The number of goods produced in Etania remains the same.

After the climate change, Chenoa must spend 45 shells to buy five pounds of vegetables. The price of vegetables is now ________. This implies that the price of vegetables has increased by _______.

Back 7

9 shells per pound, 12.5%

The increase in the number of shells in Etania caused an increase in prices. Now Chenoa must pay 45 shells for the same five pounds of vegetables, or

New Price per Pound of Vegetables = 45 Shells / 5 Pounds of Vegetables
New Price per Pound of Vegetables = 9 Shells per Pound of Vegetables

This implies that the price of vegetables increased from 8 shells per pound to 9 shells per pound for a percentage change of

Percentage Increase in Price = (New Price - Old Price) / Old Price
Percentage Increase in Price = (9 - 8) / 8
Percentage Increase in Price = 0.125
Percentage Increase in Price = 12.5%

Front 8

In the economy of Etania, changes in climate cause more of the previously rare shells to wash up onto the shore. The number of goods produced in Etania remains the same.

The price increase in Etania causes ________ in the purchasing power of shells.

Back 8

No change

The price of vegetables has increased by 12.5%. The purchasing power of a shell has decreased.

Front 9

True or False: The government can control the purchasing power of fiat money through controlling its supply.

Back 9

TRUE

Changes in the supply of money cause changes in its purchasing power. For a given level of production, an increase in the supply of money causes a decrease in money's purchasing power. People in the economy accept fiat money based on the government's implicit promise to maintain its value.

Front 10

True or False: M2 includes only the most liquid assets.

Back 10

FALSE

The Federal Reserve measures the money supply using the monetary aggregates M1, M2. These measures differ as to which assets are included. M1, the narrowest measure, includes only the most liquid assets (demand deposits and currency). M2 includes less liquid assets that are considered money only under broader definitions.

Front 11

This table illustrates how the Federal Reserve Board revises its estimate of the monetary aggregates. Each column reports an estimate of how big the three main monetary aggregates were in February 2001. The data are measured in billions of dollars. The table reports both seasonally adjusted (SA) data and non-seasonally adjusted (NSA) values for each aggregate.

Based on the table above, which of the following is true:

A) The largest data revisions are made in the weeks immediately after the initial release.

B) Large revisions take place many months after the initial release.

C) Data revisions are caused by changes in the purchasing power of money over time.

D) Data revisions are not important because they involve very small percentage changes.

Back 11

B) Large revisions take place many months after the initial release.

Comparing the figures reported on March 15, 2001 to those reported on March 14, 2002, the revisions to monetary aggregates can be quite large, as much as 8% in the case of the seasonally adjusted measure of M1. For all three aggregates, the biggest changes to the estimates come in the data release for March 14, 2002, a year after the initial data release.

Front 12

This table illustrates how the Federal Reserve Board revises its estimate of the monetary aggregates. Each column reports an estimate of how big the three main monetary aggregates were in February 2001. The data are measured in billions of dollars. The table reports both seasonally adjusted (SA) data and non-seasonally adjusted (NSA) values for each aggregate.

True or False: The table above shows that the Fed revises its estimates for the monetary aggregates. These adjustments are necessary because small depository institutions reporting to the Fed frequently make mistakes.

Back 12

FALSE

The Fed adjusts the monetary aggregates for two reasons. First, the Fed corrects for seasonal variation in the money supply. This takes a longer period to compute and is difficult to estimate in the short run. Second, small depository institutions report to the Fed infrequently, so between reporting dates, the Fed must estimate how assets change at these institutions.