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Eco 1011 - Unit 10 Summary
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10.1 Money and wealthMoney: medium of exchange (something that facilitates exchange ) consisting of bank notes and
bank deposits, or anything else that can be used to purchase goods and services, and is generally
accepted by others as payment because others can use it for the same purpose.
Barter exchange: goods are directly exchanged without money changing hands.
o Money allows purchasing power to be transferred among people (value attached)
o For money to do its work, everyone else must trust that others will accept your
money as payment (reciprocal consent)
o Trust usually provided by government & banks
Functions of money
Medium of exchange: used to purchase g&s (transfer purchasing power with reciprocal
consent – need trust to be accepted as MOE)
Store of value: retains its value of over long term – some level of predictability
o Inflation = ↓ value
o ↑ inflation = ↓ g&s able to produce (too much money:too few good) o Zimbabwe:
↑money in circulation =↑ demand for g&s = ↑ price &
production of g&s X↑= inflation
Unit of account: able to measure value
Commodity Money- It builds on scarce natural resources that act as a medium of exchange, store of
value, and unit of account. Commodity money is closely related to (and originates from) a barter
system, where goods and services are directly exchanged for other goods and services
Fiat Money- gets its value from a government order (i.e., fiat). That means, the government declares
fiat money to be legal tender, which requires all people and firms within the country to accept it as a
means of payment. Examples of fiat money include coins and bills.
Fiduciary Money- depends for its value on the confidence that it will be generally accepted as a
medium of exchange. Unlike fiat money, it is not declared legal tender by the government, which
means people are not required by law to accept it as a means of payment. Instead, the issuer of
fiduciary money promises to exchange it back for a commodity or fiat money if requested by the
bearer. As long as people are confident that this promise will not be broken, they can use fiduciary
money just like regular fiat or commodity money. Examples of fiduciary money include cheques,
banknotes, or drafts.
Commercial Bank Money- can be described as claims against financial institutions that can be used
to purchase goods or services. It represents the portion of a currency that is made of debt generated
by commercial banks. More specifically, commercial bank money is created through what we call
fractional reserve banking. Fractional reserve banking describes a process where commercial banks
give out loans worth more than the value of the actual currency they hold. At this point
just note that in essence, commercial bank money is debt generated by commercial banks that can
be exchanged for “real” money or to buy goods and services.
Wealth
Wealth: Stock (no time dimension) of things owned or value of that stock.
,= market value of buildings, land, machinery, capital goods & financial assets (bonds/shares )– debts
owed(mortgage) + debts owed to you
+ Immaterial wealth – human capital, health ( in broader definition)
↑ Wealth does not include the stock of knowledge, skills, behavioural attributes and personal
characteristics that determine an individual’s labour productivity.
Human capital: The stock of knowledge, skills, behavioural attributes, and personal
characteristics that determine the labour productivity or labour earnings of an individual.
Investment in this through
Education
Training
socialization
= can increase the stock, and such investment is one of the sources of economic growth.
Part of an individual’s endowments.
Income
Income: The amount of money one receives over some period of time (flow) from market
earnings, investments, government.
The amount of profit, interest, rent, labour earnings, and other payments (including
transfers from the government) received, net of taxes paid, measured over a period of
time.
NET income = The maximum amount that you could consume and leave your wealth
unchanged
Depreciation: loss in value of a form of wealth that occurs either through use (wear and tear) or
the passage of time (obsolescence).
Net income Gross income - depreciation.
, Flow: A quantity measured per unit of time
Stock: A quantity measured at a point in time. Its units do not depend on time
75 year old 30 year old
Wealth 1 million Wealth of -100 000
Income R10 000 Income of 35 000
Older people normally have more wealth
Wealth = capital and assets the one own
Income= the amount of money made at a time
Depreciation = Reduction in the value of a stock of wealth over time.
Net income = The maximum amount that one could consume without running down wealth.
Net income = gross income – depreciation
Earnings = Wages, salaries, and other income from labour. - flow
Savings = Income that is not consumed Y=C+S and S=Y-C
Investment = Expenditure on newly produced capital goods
Expenditure
Consumption (C) Expenditure on consumer goods including both short-lived goods and services
and long-lived goods, which are called consumer durables.
C < Net income = ↑ wealth
C > Net income = ↓ wealth
Saving: When consumption expenditure is less than net income, saving takes place and wealth
rises. E.g. financial assets – bonds, shares. Income that is not consumed
Investment (I) Expenditure on newly produced capital goods (machinery and equipment) and
buildings, including new housing
Earnings = Wages, salaries, and other income from labour
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