Quiz 13: Money and the Banking System


This asset is illiquid implies that concerned asset could not be converted into money in quick and easy manner and that also without a loss in its value. This phenomena is mostly associated with the assets such as land or houses because it will take ample amount of time to locate a buyer for these assets and if seller try to expedite the process he have to sell the asset at much lower value than its potential value and thus have to suffer a loss in value. So, in this sense assets such as house or land are generally considered as illiquid assets. Some things that we own are as follows - 1. Checking account in Bank of America. 2. Apple iPhone. 3. House 4. Stocks of Microsoft 5. Car 6. Cash Arrangement of above listed assets from most liquid to most illiquid are as follows - 1. Cash 2. Checking account with Bank of America 3. Stock of Microsoft 4. Apple iPhone 5. Car 6. House

Ability of the financial asset to be used as a medium of exchange determines whether a financial asset will be included in the M1 money supply or not. For example, if a financial asset is readily be used as medium of exchange then it would be included in the M1 money supply otherwise not. Interest-earning checkable deposits are included in M1 whereas interest - earning savings accounts and Treasury bills are not because as stated above M1 only includes those financial assets that can readily be used as medium of exchange and interest-earning checkable deposits can readily be used as medium of exchange and so are included in M1. On the other hand, interest-earning savings accounts and Treasury bills could not directly be used as medium of exchange. They first have to be converted into currency or checking deposits and then can be used for making payment or medium of exchange. Hence, they are not included in M1.

Money is valuable because of the following functions it performs - 1. Money acts as medium of exchange. Money provides a means to exchange goods and services with ease. It has plugged all the loopholes of barter system and has given a boost to economic activities around the world. 2. Money acts as store of value. Money provides a means to the person through which he or she can store his or her wealth for future use without fear of it being deteriorated in value. 3. Money acts as unit of account. Money provides a measure through which value of goods and services is ascertained and even though unit of measurement of goods and services differ, they are converted into one value due to money and thus made comparable. Money, in this way, works as common denominator that expresses both cost and benefits of goods and services and provide consumer with a yardstick to compare the costs of wide variety of goods and services. Money indeed performs an economic service in the sense that money has made the exchange of goods and services far easier. This has led to the expansion of trade and commerce resulting in rising standard of living across the globe. Money has removed the difficulties in trade by reducing the cost of transaction and simplifying the process of trade which was very complicated under the barter system. Thus, money has played an important role in economic integration of world. Money could not be able to perform its function better if there were twice as much of it because value of money, like other commodities, depends on its supply relative to the demand for it. Money provides the purchasing power. Through money a person can buy goods and services. If supply of money rise faster than the production of goods and services then in such case it contributes towards price rise and diminishes the purchasing power of the individual and thus becomes less valuable as a means of exchange. Thus, supply of money has to remain limited so that its value remains stable over time and it remains valuable as a medium of exchange and store of value - two important functions of money.

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