Definition, Measurement, and Functions of Money - AP Macroeconomics
- What is the classical dichotomy?
- Theoretical separation of real and nominal variables in the economy. Money affects nominal but not real economic variables.
- What is fiat money?
- Currency without intrinsic value, established by government decree. Backed by government authority, not physical commodities.
- Define commodity money.
- Money that has intrinsic value, such as gold or silver. Value comes from the material itself, not government backing.
- What is the real interest rate?
- Nominal interest rate minus inflation rate. Shows the true purchasing power of borrowed money.
- What is a liquidity trap?
- Situation where monetary policy is ineffective due to low interest rates. Occurs when interest rates approach zero percent.
- Identify the role of money as a standard of deferred payment.
- Facilitates transactions over time, enabling credit and loans. Money allows payments to be made in the future.
- Define the unit of account function of money.
- Standard numerical unit for pricing goods and services. Allows comparison of relative values across different items.
- Define monetary neutrality.
- Concept that changes in money supply only affect nominal variables. Money changes don't affect real economic activity long-term.
- Identify the three primary functions of money.
- Medium of exchange, unit of account, store of value. These functions make money useful in modern economies.
- What is the Fisher equation?
- , where is nominal interest rate, is real rate. Links nominal and real interest rates through inflation.
- Define liquidity in the context of money.
- Ease with which an asset can be converted into cash. Cash is perfectly liquid; other assets vary in liquidity.
- What is the main consequence of inflation?
- Erodes purchasing power of money. Same amount of money buys fewer goods and services.
- What is the medium of exchange function of money?
- Facilitates transactions by eliminating the need for barter. Avoids the inefficiency of trading goods directly.
- What is an open market operation?
- Buying or selling government securities to influence money supply. Primary tool for implementing monetary policy decisions.
- What is the money supply?
- Total amount of monetary assets available in an economy. Controlled by central banks to influence economic activity.
- What is Gresham's law?
- Bad money drives out good money when both are legal tender. People hoard valuable money and spend less valuable money.
- What is the velocity of money?
- Rate at which money circulates in the economy. Higher velocity means money changes hands more frequently.
- What is the money multiplier?
- Ratio of the amount of money created by lending to the reserve ratio. Calculated as .
- What is quantitative easing?
- Central bank buys securities to increase money supply and encourage lending. Used when traditional monetary policy becomes ineffective.
- What does the store of value function of money entail?
- Preserves wealth for future use, retaining value over time. Money maintains purchasing power across time periods.
- What is hyperinflation?
- Extremely rapid and high inflation, eroding currency's value. Often caused by excessive money printing by governments.
- What does the Federal Reserve use to control the money supply?
- Open market operations, discount rate, reserve requirements. These are the Fed's three main monetary policy tools.
- What is deflation?
- Sustained decrease in the general price level of goods and services. Opposite of inflation; prices generally fall over time.
- What does M1 include in the money supply?
- Currency, demand deposits, traveler's checks, other checkable deposits. Most liquid forms of money readily available for spending.
- What is the primary disadvantage of barter?
- Requires a double coincidence of wants. Both parties must want what the other offers.
- What is the equation of exchange?
- MV = PQ, where M is money supply, V is velocity, P is price level, Q is output. Shows relationship between money, prices, and economic output.
- Define the discount rate.
- Interest rate at which banks borrow short-term funds from the Federal Reserve. Higher rates discourage borrowing; lower rates encourage it.
- What is the purpose of a central bank?
- Manage monetary policy, stabilize the currency, act as lender of last resort. Provides stability and oversight for the financial system.
- Identify a key feature of electronic money.
- Stored electronically, facilitates transactions via digital platforms. Includes digital currencies, credit cards, and mobile payments.
- What is the definition of money in economics?
- Money is any item accepted as payment for goods and services. Must be widely accepted and trusted by society.
- List the components of M2 in the money supply.
- M1 plus savings deposits, small time deposits, money market funds. Broader measure including less liquid but accessible funds.
- Define the term 'currency debasement'.
- Reducing the value of currency by lowering its metal content. Historical practice that reduced currency's intrinsic worth.
- What are reserve requirements?
- Minimum reserves a bank must hold against deposits. Higher requirements reduce lending; lower requirements increase it.
- What is the monetary base?
- Sum of currency in circulation and reserves held by banks. Foundation upon which the broader money supply is built.
- What is seigniorage?
- Revenue earned by the government from issuing currency. Government profits from the difference between face value and production cost.
- What is representative money?
- Money that represents a claim on a commodity, like a gold certificate. Can be exchanged for the underlying commodity it represents.
- Define nominal interest rate.
- Interest rate not adjusted for inflation. The actual rate stated on loans and investments.
- What does 'legal tender' mean?
- Currency that must be accepted if offered in payment of a debt. Law requires acceptance for debt payment obligations.