Definition Of Money Supply In Economics – Money is a value system that facilitates the exchange of goods in an economy. Using cash allows buyers and sellers to pay fewer transaction fees compared to bartering.
The first type of money is commodity. Their physical properties make them desirable as a medium of exchange. In today’s markets, money can include government-issued legal tender, money substitutes, fiduciary media, or electronic cryptocurrencies.
Definition Of Money Supply In Economics
Money is a liquid asset that is used to facilitate transactions of value. It is used as a medium of exchange between individuals and entities. It is also a store of value and a unit of account by which other goods can be measured.
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Prior to the invention of money, most economies relied on bartering, in which individuals directly traded the goods they owned for those who needed them. As a result, the problem of double coincidence of wants arises: a transaction can take place only if both participants have something that the other needs. Money eliminates this problem by acting as an intermediary good.
The first known forms of money were agricultural goods, such as grain or livestock. These items are in demand and traders know they can use or trade these items again in the future. Cocoa beans, cowrie shells and farm implements also served as early forms of money.
As the economy became more complex, money standardized into currency. This reduces transaction costs by making it easier to measure and compare values. Also, representations of money are becoming increasingly abstract, from precious metals and stamped coins to banknotes and, in modern times, electronic notes.
During World War II, cigarettes became the de facto currency for soldiers in prisoner of war camps. The use of cigarettes as money made tobacco highly desirable, even among soldiers who didn’t smoke.
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To be most useful, money must be exchangeable, durable, portable, recognizable and stable. This property reduces the transaction costs of using money by making it easy to exchange.
The word fungible refers to the quality whereby one thing can be exchanged, replaced, or returned for another thing, assuming equal value. So units of money must be interchangeable with each other.
For example, metal coins must be of standard weight and purity. Commodity money must have a relatively uniform quality. Attempting to use non-fungible goods as money generates transaction costs that require individual evaluation of each unit of goods before exchange can be made.
Money must be durable enough to maintain its usefulness for many future exchanges. Perishable goods or goods that break quickly through multiple exchanges will be less useful for future transactions. Trying to use non-perishables for money goes against the future-oriented use and value of money.
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Money should be easy to carry and distribute, so that valuable sums can be carried alone or transported. For example, trying to use items that are difficult or inconvenient to carry as money may require physical transportation resulting in transaction costs.
The authenticity and quantity of the goods must be easily visible to users, so that they can easily agree to exchange terms. Using a commodity that cannot be recognized as money can result in transaction costs associated with authenticating the commodity and agreeing on the required amount for exchange.
The supply of goods used as money must be relatively constant over time to avoid fluctuations in value. Using volatile assets as money generates transaction costs because of the risk that their value will increase or decrease, due to scarcity or abundance, for subsequent transactions.
Money works especially when the right people use it to exchange for valuables. However, it also has a secondary function that arises from its use as a medium of exchange.
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By using money as a medium of exchange for buying and selling and as an indicator of value for all kinds of goods and services, money can be used as a unit of account.
This means money can track changes in the value of goods over time and some transactions. People can use it to compare the value of different combinations or quantities of goods and services.
Money as a unit of account makes it possible to account for profits and losses, balance budgets and assess the total assets of a company.
The use of money as a medium of exchange in transactions is basically future-oriented. Thus, it provides a means to store monetary value for future use without reducing this value.
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So, when people exchange goods for money, that money has a certain value that can be used in other transactions. The ability to function as a store of value facilitates saving for the future and making remote transactions.
To the extent that money is accepted as a medium of exchange and serves as a useful store of value, it can be used to transfer value over different periods in the form of credit and debt.
One person can borrow a certain amount of money from another person for an agreed period of time, and repay the agreed amount of money at a future date.
Money can arise from spontaneous market orders. If traders trade different goods, some goods will prove more convenient than others because they have the best combination of the five properties of money listed above.
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Over time, these items may be desired as objects of exchange, rather than practical use. Finally, one can expect good only for future trades.
Historically, precious metals such as gold and silver were often used as market currency. They are highly valued in various cultures and societies. Today, people in cashless economies often turn to cigarettes, instant noodles, or other non-perishable goods in lieu of branded cash.
When a certain type of money is widely accepted in the economy, government agencies can begin to regulate it as a currency. They can issue standard coins or notes to further reduce transaction fees.
Governments can also recognize certain amounts of money as legal tender, meaning that courts and government agencies must accept money in that form as a last resort.
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Issuing money allows the government to profit from seigniorage, the difference between the face value of a coin and the cost of producing it.
For example, if it cost only $10 to print a $100 bill, the government would make a profit of $90 for each note it printed. However, a government that relies too heavily on seigniorage could inadvertently devalue its currency.
Many countries issue fiat currency, that is, currency that does not represent any commodity. Instead, fiat money is backed by the economic power of the outgoing government. It gets its value from supply and demand and government stability.
Fiat money allows the issuing government to carry out economic policies by increasing or decreasing the money supply. In the US, the Federal Reserve and the Department of the Treasury control different types of money supply to regulate and mitigate monetary problems.
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Since fiat money does not represent a real commodity, the issuing government must ensure that it fulfills the five properties of money outlined above.
The International Monetary Fund (IMF) and the World Bank serve as global watchdogs for international currency exchange. Governments can institute capital controls or set pegs to stabilize their currencies in international markets.
To lighten the burden of carrying large amounts of currency, merchants and dealers sometimes exchanged substitutes for money, such as written promissory notes that could be redeemed later. These statements can even take on some of the properties of money, especially if traders use them instead of actual currency.
For example, old banks issued bills to their depositors, where the amount deposited and the terms of redemption. Instead of withdrawing money from the bank to make payments, depositors would simply trade their bills, allowing the recipient to redeem or trade them at will.
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The use of these currency substitutes can increase the portability and durability of money, as well as reduce storage costs. However, there are risks associated with refunds. Banks are allowed to print more bills than they have cash to redeem, a practice known as fractional reserve banking. If too many people try to make withdrawals at the same time, the bank may experience a bank run.
Fiduciary media is a type of substitute money that is introduced into circulation which is not fully supported by the principal money held to support the replacement money. For example, paper checks, token coins, and electronic credit are contemporary examples of fiduciary media.
In recent years, digital currencies that do not exist in physical form, such as Bitcoin, have been introduced. Unlike electronic bank notes or payment systems, virtual currencies are not issued by governments or other central bodies. Cryptocurrencies have some of the properties of money and are sometimes used in online transactions.
Although cryptocurrencies are rarely used in daily transactions, they have attained some uses as speculative investments or stores of value. Several jurisdictions have recognized cryptocurrencies as a medium of payment, including the government of El
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