Fundamentals of Economics Individual as Producer, Consumer and Borrower: Money

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Money

  • Medium of exchange
  • Banknotes, coins, gold & bank deposits

Characteristics

  • Durability – last long, made of polymer ( 1st in Australia in 1988) ; US dollar can be folded 4000 times forward and backward before tearing. Singapore, Brunei, Hong Kong & Australia – polymer notes. Notes last 9 years and coins around 30 years as per US.
  • Acceptability – official tender, gold is universally accepted. Zimbabwean dollar ceased to be accepted as a medium of exchange in 2009 when the country, which had been suffering from civil unrest, experienced hyperinflation. In October 2008, Zimbabweans needed Z $ 2621984228 to purchase US $ 1 worth of goods.
  • Divisibility – it must be divisible (earlier cattle and cow used and not divisible)
  • Uniformity – look identical in shape, size, appearance (cows not uniform) - The first consistent form of money, cowry shells, was used in China over 3200 years ago. These seashells were used for mainly trading food, livestock and textiles.
  • Scarcity – limited quantity; seashells and salt in past as money but supply was too much and lost importance.
  • Portability – usually weight of 1 note is 1 gm (help electronic payment without cash) . The first coins used as money appeared around 2000 BC.

Functions of Money

  • Medium of exchange – for trade
  • Measure of value – unit of account and measures market value
  • Store of value – hold the value and can be used later
  • Standard of deferred payment – standard for future payments (loans taken today are repaid sometime in future)

Bartering & Need for Exchange

Bartering is the act of swapping items in exchange for other items through a process of bargaining and negotiation Problems

  • Double coincidence of wants - the person with chickens must find a trader who wants chickens in exchange for their sheep. As two people engaged in a trade must both want what the other person is offering, bartering is highly inefficient.
  • Divisibility – sheep cannot be traded
  • Portability – sheep to be moved from one location to another

Central Bank Functions

  • Sole issuer of banknotes and coins
  • Government bank
  • Banker՚s bank
  • Lender of Last Resort
  • Central bank - Oversee and manage nation՚s money supply and banking system – oversee monetary policy, responsible for entire money supply & manipulation of interest rates
  • European Central Bank (for the Eurozone countries) , the USA՚s Federal Reserve, the Bank of England, the People՚s Bank of China and the Reserve Bank of India
  • USA՚s Federal Reserve – formed in Dec 1913.
  • Issuer of Notes: only authority that can print banknotes and mint coins – bring uniformity, improve public confidence. Exception- Hong Kong where three commercial banks (Standard Chartered, HSBC and Bank of China) have note-issuing rights, although the Hong Kong Monetary Authority maintains overall control of the country՚s banking system, including the circulation of banknotes and coins.
  • Govt. Bank: Maintain bank account of central government – receive deposit, short term loans, manage public-sector debt, stabilize external value of nation՚s currency
  • Banker՚s bank: oversee cash reserves of commercial banks. cheque clearing function of the central bank reduces the need for cash withdrawals, thus enabling commercial banks to function more efficiently. Overview liquidity position
  • Lender of last resort: commercial bank keep % of cash with central bank as reserve – can be used during financial emergencies
  • A bailout refers to a loan or financial assistance provided to a company (or country) which faces bankruptcy and financial difficulties. Aim was to prevent job loss and socioeconomic failure. Cyprus invested $ 10 billion in bailout (56 % of GDP)

Stock Exchange/Bourse

  • Stock exchange - institutional marketplace for trading the shares of public limited companies. New York Stock Exchange (NYSE) , London Stock Exchange, Frankfurt Stock Exchange, Shanghai Stock Exchange and Bombay Stock Exchange.
  • Create business, consumer confidence, boost investment

Function

  • Raising share capital for businesses: stock exchange provides public limited companies with the facility to raise huge amounts of finance. Share capital is main source of finance. IPO (Initial Public Offering) – many companies go public by selling shares on stock exchange for 1st time. Popular ones get oversubscribed and this forces share prices upward. Existing companies that are listed on a stock exchange can raise more share capital by selling additional sales in a share issue (or a share placement) . But by issuing more shares, ownership and control of the company become weakened.
  • Facilitating company growth: Share issue – Along with IPO sell additional shares to raise funds. Perrobras - Brazil՚s largest oil company - managed to raise $ 70 billion from selling additional shares to the general public in September 2010. Growth by mergers and acquisitions - Walt Disney Company acquired Lucasfilm (creators of the best-selling Star Wars franchise) via the New York Stock Exchange in 2012 for $ 4.05 billion.
  • Facilitating sale of government bonds (type of loan) - Bondholders do not have ownership rights, but earn interest based on the number of bonds bought and the prevailing interest rate. Finance from govt. bond funds infrastructure
  • Price mechanism for trading shares – determined by relative demand and supply. Price fluctuation and valuation handled by stock exchange.
  • Safety of transactions – companies that trade are regulated and share dealings are defined with legal framework. This helps to boost the level of confidence in buying and selling shares – impact growth and capital formation

Commercial Banks

  • Maintain deposit
  • Transaction are socially & legally governed by central bank
  • A commercial bank is a retail bank that provides financial services to its customers, such as accepting savings deposits and approving bank loans.
  • Commercial banking started 200 years ago when goldsmith operated as banks.
  • Banking itself can be traced to 2000 BC when merchants in Assyria and Babylonia used grain loans to farmers and other traders. Modern commercial banking using the internet (e -banking) did not start until 1995.

Primary Functions

  • Accept deposits – sight deposit (payable on demand) & time deposit (payable after fixed time) . Time deposit attract higher rate of deposits
  • Making advance – advance loan to customers – overdraft & mortgage
  • Credit Creation – bank increase supply of money in economy by making money available to borrowers. Generate additional purchasing power but cannot create credit (print notes)

Secondary Functions

  • Collect and clear cheque on behalf of client
  • Additional financial services
  • Safety deposit box – lockers – jewelry and documents
  • Money transfer facility
  • Credit card facility
  • Internet banking facility

Overdrafts (a banking service that allows registered customers to withdraw more money than they actually have in their account)

Mortgages (long-term secured loans for the purchase of assets such as commercial and residential property) .

✍ Manishika