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McGraw-Hill/Irwin
SECTION I
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Money: Characteristics
1. Means of payment
Used in exchange for goods & services
2. Unit of account
Used to quote prices
3. Store of value
Used to move purchasing power into the future
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Barter System
Direct exchange of one commodity or service for another without the use of money. It is a Money Less Economy.
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Commodity Money: Skin, arrows, cattle, wheat, rice etc. Metallic Money: gold & silver Coins:
11th Century BC in China Full Bodied Coins of Gold & Silver Now a days only Token Coins are issued. Initiated in 17th century in Sweden. Currency Notes are used as Legal Tender now a days.
d) e)
Paper Money:
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Functions of Money
Primary Functions:
Medium of Exchange Store of Value Unit of Measurement
Secondary Functions
Monetary & Fiscal Management Deferred Payments / Future Payments Economic Activities & Determination of Prices Promotion of Foreign Trade Transfer of Wealth Basis for Credit System
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Demerits of Money
Cause of Crime Inequalities in Distribution Fluctuations in Value Cyclic Fluctuations Good servant & Bad master
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Fiat Money:
Value comes from government decree (or fiat)
Checks:
Instructions to the bank to shifts funds from your account to that of the person or firm whose name is written in the Pay to the Order of line.
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Checks are legal proof of payment Customers wanted them back Starting in 2004
Banks can transmit digital images Substitute checks are proof of payment
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E-Money
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Debit cards:
Like a check Electronic message to your bank to transfer funds immediately
Credit cards:
Deferred payment Issuer makes payment for you You have to pay it back
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Technological advances create new methods of payment. Cell phones and other types of handheld mobile devices are providing access to the payments system. What will be next?
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Measuring Money
Changes in the quantity of money are related to
Interest Rates Economic Growth Inflation
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2. Monetarists Approach
Money is a temporary abode of Purchasing Power It includes Currency (C), Demand Deposits (D) and Time Deposits (T) M=C+D+T
3. Liquidity Approach
Broader Definition Also includes all other financial instruments which have high liquidity. It includes, M = C + D + T + Repos + Comm. Papers etc.
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Paper Money
Paper Money means documents with a value stated on them but having no intrinsic value in them. Kinds of Paper Money:
1. Representative Paper Money 2. Convertible Paper Money 3. Non-convertible Paper Money
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Fiat Money
Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.
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P = MV + MV / T
Where
P = Price Level M = the Total Quantity of Legal Tender Money V = the Velocity of Money in Circulation M = the Total Quantity of Credit Money V = the Velocity of Circulation of M T = the Total Amount of Goods & Services exchanged for Money, i.e. Transactions
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The raw inflation figure as reported through the Consumer Price Index (CPI) that is released monthly by the Bureau of Labor Statistics.
The CPI calculates the cost to purchase a fixed basket of goods as a way of determining how much inflation is occurring in the broad economy. The CPI uses a base year and indexes current year prices based on the base year's values. The headline figure is not adjusted for seasonality or for the often volatile elements of food and energy prices, which are removed in the Core CPI. Headline inflation will usually be quoted on an annualized basis, meaning that a monthly headline figure of 4% inflation equates to a monthly rate that, if repeated for 12 months, would create 4% inflation for the year. Comparisons of headline inflation are typically made on a year-overyear basis.
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Other Terminologies:
Deflation: Increasing value of Money Hyper Inflation: Very High Rate Inflation (>25%) Stagflation: Inflation + High Rate Unemployment Creeping Inflation: Slow Rate of Inflation (<3%) Running Inflation: Usually for growing Economies (8% - 10%) Reflation: Deliberately undertaken inflation to relieve a depression.
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Assignment:
Causes of Inflation in General Causes of Inflation in Pakistan Remedial Measures for Inflation in General Remedial Measures for Inflation in Pakistan
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Measuring Inflation
Visit the site: http://www.statpak.gov.pk/depts/fbs/statis tics/price_statistics/methodology_price_ statistics.html
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Measures of Inflation
Fixed-weight Index - CPI
Deflator GDP or Personal Consumption Expenditure Deflator Chain-weight index Half way between fixed-weight and a deflator.
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Chapter 2
End of Chapter
McGraw-Hill/Irwin