Concept of money, Microeconomics

The Concept of Money:

Money or paper currency serves three functions in any case: it is the medium of exchange, a store of value and the unit of account. Before paper money was introduced (and we are hear talking about not so long ago), people used coins which had intrinsic value such as gold, silver, bronze. Before that there was the barter trade, where goods and services were exchanged for the goods and services and there was no monetary medium of exchange.

Money Supply and Its Various Definitions are given below:

There is a process/method by which the money is created – the process of money supply, and there are ideas about why the people hold money – money demand theories. We’ll tackle these in order and then develop the understanding of money market equilibrium.

Before getting a grip of the money supply process, we should understand the various definitions of the money supply (denoted by Ms). At this introductory point, we’ll introduce only three definitions of money supply:

a.  M0: also called the base money, high powered money or the monetary base. M0 is the actual value of all the currency notes and coins which are in circulation in the economy. Note that any of the currency or coins lying with the central bank (which in the Pakistan’s situation would be the State Bank of Pakistan) does not count as the M0, as it is not in the circulation.

b.  M1: is M0 + all current (or the checking) deposits held with the commercial banks. Checking deposits are the accounts from which the holders/owners can withdraw money at any time.

c.   M2: is M1 + deposits of all the. Time deposits are accounts from which the holders can withdraw money only after giving banks some notice (usually the time period is few months). When talking about the money supply, this is the measure we often refer to. The relationship between M2 and M0 is the key for unravelling the money supply process. If you are wondering how the money supply can be larger than M0, take one simple answer (in QTM vein). A 100 rupee note counts Rs. 100 only for the M0; but if the same note goes round the economy and changes hands 5 times in the year, then the value of the same 100 rupee note is Rs. 500 in an M2 situation. From the definition of M2 and M0, though, it is clear that there is work the commercial banks do which causes the value of the same 100 rupee note to increases from Rs. 100 to Rs. 500.

Posted Date: 7/19/2012 4:09:16 AM | Location : United States

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