Money | Economics for JAMB PDF Download

Types, Characteristics, and Functions of Money

Types of Money:

• Commodity Money: Consists of physical objects with intrinsic value, such as gold or silver coins.
• Fiat Money: Has no intrinsic value and is declared legal tender by the government, such as paper currency or coins.

Characteristics of Money:

• Acceptability: Money must be widely accepted as a medium of exchange in transactions.
• Divisibility: Money should be easily divisible into smaller units to facilitate transactions of varying values.
• Durability: Money should withstand wear and tear to ensure its longevity.
• Portability: Money should be easy to carry and transport.
• Uniformity: Each unit of money should be the same as every other unit.

Functions of Money:

• Medium of Exchange: Money serves as a widely accepted medium for buying and selling goods and services.
• Unit of Account: Money provides a standard unit for measuring and comparing the value of goods and services.
• Store of Value: Money can be saved and held for future use, preserving purchasing power over time.
• Standard of Deferred Payment: Money allows for the settlement of debts and future obligations.

Demand for Money and the Supply of Money

Factors Affecting Demand for Money:

• Interest Rates: Higher interest rates reduce the demand for money as people are incentivized to save rather than hold cash.
• Income Levels: Higher incomes generally lead to an increased demand for money to facilitate increased spending.
• Price Levels: Higher prices may increase the demand for money as more cash is needed to make purchases.
• Transaction Costs: Higher transaction costs, such as fees or inconvenience, may decrease the demand for money.

Factors Affecting Supply of Money:

• Central Bank Policies: The central bank influences the money supply through measures such as open market operations, reserve requirements, and interest rate adjustments.
• Government Spending: Government expenditures impact the money supply as they inject funds into the economy.
• Bank Lending: The lending activities of commercial banks affect the money supply through the creation of new loans and deposits.

Quantity Theory of Money (Fisher Equation)

Components of the Quantity Theory of Money:

• The Quantity Theory of Money states that the general price level is directly proportional to the money supply in an economy, assuming a constant velocity of money.

The equation is expressed as: MV = PT

• M: Money Supply
• V: Velocity of Money (the average rate at which money changes hands in transactions)
• P: Price Level
• T: Volume of Transactions (the quantity of goods and services exchanged)

The Fisher Equation further expands the theory by incorporating the nominal interest rate (i):
MV = PT = Y * i
where Y is the real output or income.

The Value of Money and the Price Level

Relationship between Value of Money and Price Level:

• Inflation: When the price level rises, the value of money decreases. Inflation erodes the purchasing power of money.
• Deflation: When the price level falls, the value of money increases. Deflation increases the purchasing power of money.
• Real versus Nominal Value: The real value of money considers its purchasing power in terms of goods and services, while the nominal value refers to the face value of money.
• Price Indices: Measures such as the Consumer Price Index (CPI) or the Producer Price Index (PPI) are used to track changes in the overall price level.
• Impact on Saving and Investment: Changes in the value of money affect saving and investment decisions, as individuals and businesses consider the expected future purchasing power of their money.