Deck 13: Money and the Financial System

Question 1

BARTER Define a double coincidence of wants and explain its role in a barter system.

Answer 1

Double coincidence of wants:
Double coincidence of wants refers to a situation where two suppliers exchange their goods to each other to meet their wants. Thus, it is essential for a trade to have double coincidence of wants in a barter system.
Role of double coincidence of wants in barter system:
Suppose, a farmer wants to sell wheat which he/she has produced and wants to buy cloth in exchange for it, at the same time a weaver wants to sell cloth and wants to buy wheat for cloth. They both would exchange their goods among themselves and fulfill their wants. Hence, the barter system of market takes place where there is occurrence of double coincidence of wants i.e., possibility of occurrence of two trades to directly exchange their goods among themselves and meet their wants.

Question 2

MONEY VERSUS BARTER "Without money, everything would be more expensive." Explain this statement. Then take a look at a Web page devoted to barter at http://www.ex.ac.uk/~RDavies/arian/barter.html. What are some current developments in barter exchange?

Answer 2

Barter system at present:
In the absence of money, it will be very difficult to exchange two commodities having unequal value. Therefore, it is easy to sell a product by giving monetary weight. The value of the product is known in terms of money, and it makes the transaction easier and faster; which in turn reduces the transaction cost.
There are some markets, where barter system is still present.
• Exchange of information through internet facility is a kind of barter economic system.
• Printing press and internet facilitates the double coincidence of wants, which is a kind of barter economic system.

Question 3

FUNCTIONS OF MONEY What are the three important functions of money? Define each of them.

Answer 3

Following are the three major functions of money:
In barter system, people trade their goods in exchange of others good; but if a seller wants to sell his/her good without buying another trader's good, then the trade may not take place. Thus, to avoid such a situation, money has been introduced.
Medium of exchange:
Medium of exchange refers to anything which is accepted in terms of payment for the exchange of goods between traders in the market.
Unit of account:
Another major function of money is that, it can measure the value of a product in the form of quantity. In barter system, a major difficulty was to identify the standard of measure, i.e., how much quantity has to be given in terms of exchange of other goods. Hence, money has served as a unit of measure.
Store of value:
Money is considered as a store of value as it stores surplus purchasing power and helps in accumulating capital formation in future. Money can be stored for a long period in the form of security and also the possibility to destroy is less.

Question 4

FUNCTIONS OF MONEY "If an economy had only two goods (both nondurable ), there would be no need for money because exchange would always be between those two goods." What important function of money does this statement disregard?

Question 5

CHARACTERISTICS OF MONEY Why is universal acceptability such an important characteristic of money? What other characteristics can you think of that might be important to market participants?

Question 6

COMMODITY MONEY Why do you think rice was chosen to serve as money in medieval Japan? What would happen to the price level if there was a particularly good rice harvest one year?

Question 7

COMMODITY MONEY Early in U.S. history, tobacco was used as money. If you were a tobacco farmer and had two loads of tobacco that were of different qualities, which would you supply as money and which would you supply for smoking? Under what conditions would you use both types of tobacco for money?

Question 8

ORIGINS OF BANKING Discuss the various ways in which London goldsmiths functioned as early banks.

Question 9

TYPES OF MONEY Complete each of the following sentences:
a. A product that serves both as money and as a commodity is _______.
b. Most coins and all paper money circulating in the United States have face values that exceed the value of the materials from which they are made. Therefore, they are forms of _______.
c. If the government declares that creditors must accept a form of money as payment for debts, the money becomes _______.
d. A common unit for measuring the value of every good or service in the economy is known as a(n) _______.

Question 10

FIAT MONEY Most economists believe that the better fiat money serves as a store of value, the more acceptable it is. What does this statement mean? How could people lose faith in money?

Question 11

THE VALUE OF MONEY When the value of money was based on its gold content, new discoveries of gold were frequently followed by periods of inflation. Explain.

Question 12

Case Study: Mackerel Economics in Federal Prisons
How well do pouches of mackerel satisfy the six properties of ideal money listed in Exhibit 1?

Question 13

DEPOSITORY INSTITUTIONS What is a depository institution, and what types of depository institutions are found in the United States? How do they act as intermediaries between savers and borrowers? Why do they play this role?

Question 14

FEDERAL RESERVE SYSTEM What are the main powers and responsibilities of the Federal Reserve System?

Question 15

BANK DEREGULATION Some economists argue that deregulating the interest rates that could be paid on deposits combined with deposit insurance led to the insolvency of many depository institutions. On what basis do they make such an argument?

Question 16

THE STRUCTURE OF U.S. BANKING Discuss the impact of bank mergers on the structure of American banking. Why do banks merge?

Question 17

INCENTIVE PROBLEMS AND THE FINANCIAL CRISIS OF 2008 What incentives motivated the behaviors that caused the financial crisis of 2008?

Question 18

DODD-FRANK ACT What are some goals of the Dodd-Frank legislation, and what are some possible unintended consequences of the measure?