Question No a) Under a barter system it is difficult to store purchasing power, because many goods deteriorate over time. If money was introduced which function of money would eliminate this problem? Generally every goods have some expiry date associated with it. As the times move on the quality of the goods started to detoriated. Likewise, Money also loses its value as the time moves on. Generally two factors associated with the money that can eliminate the problem of purchasing power storage. These are the interest rates and the opportunity cost of money(61).
It is a proven fact that money generally loses its value with the time. So $100 of present day cannot yield same volume of goods in the future. If the people of any country can get a clear idea about what will be the interest rates and also the opportunity cost of money than they can easily find it out that to maintain same kind of lifestyle, how much they need to have in their bank. Generally this future measurement of money on the basis of interest rates and the opportunity cost can help the people of any country to store their purchasing power for the future. b) Which function of money conveniently allows a way of placing value on goods and services and why? Monetary policy adopted by the government of every country is one of the key points associated with the measurement of future value of currency.
The monetary policy is associated with the interest rates set by the government. Generally the interest rates help to make $ 100 of today $ 110 of tomorrow or may be after a certain period of time depending on the interest rate and amount of time the money is invested.
One of the key factors associated with the interest rates is inflation. (81) Generally there are two kinds of interest rates associated with the economics, one is real interest rate and the other one is nominal interest rates. “If nominal rates do not increase lenders might receive more nominal dollars than they lent but actually get back less purchasing power” (81) because inflation might increase the price of goods and service during that time frame.
Therefore the calculation of real and actual interest value is the key behind playing a value on goods and services for the future based on the trend of the economy from the past. Following illustration is a simple example to understand as well as calculate the relation between inflations and interest rates: i=ir+π; here i stands for nominal interest rates; ir stands for real interest rates and π stands for the rate of inflation. Question No: 2 What is meant by the money supply and what are its components? The money supply can be defined as a group of safe assets that families and other business entities can utilize to make expenses or to hold as their short-term investments. (Federal Reserve).
In economic terms one can define the concept of money supply as the total properties of stock that is acknowledged as a conversation media at any given time in an economy. Generally in any economy with the increase of the interest rates, the demand for liquid cash is started to go down as every individual wants to get better yield by investing their money against various forms of bonds and other assets.
On the other hand, with the decreasing rate of interest, demand for money always increases as people less reluctant to hold on to their bonds or debentures. (100). In very simple term the money supply refers to the amount of money available in the economy. There are there basic components associated with money supply namely M0; M1 and M2. M0 refers to the available money with the common people, deposits of various nationalized and private banks with the central bank of the nation along with the cash reserve of the central bank.
In other way one can refer M0 as the monetary base of any economy. M1 is refers to currency outside the banking system and the transaction currency of various banks current account liabilities. Foreign currency reserves are also considered as a part ofM1. The M2 section of money supply attempts to enlarge the liquid properties choice to add up few interest earning substances such as fixed deposits, saving deposits or time deposits etc. In very general terms, the two main component of money supply are the currency components and depository components.
In various underdeveloped and developing nations, currency component of money supply is more appropriate where as in developed nations the depository components are more applicable. (Nadar, 56) One can also refer M1 as the difference between Mo and amount of m0 in safe place plus the total balance that the country have in their current accounts. Likewise, M2can also be referred as total of the value of M1, time deposits and the money market accounts.
In modern times economist also considers an additional factor associated with money supply M3, which is the sum total ofM2, CD or cash deposits, and the total availability of foreign currency (mainly the Eurodollars) available with the nation. (Maugham, 31) Reference: Federal Reserve System. What is the money supply? Is it important? 2014; Web; retrieved on 8.7.2014 Maugham Craig. Surviving the Debt Crisis. Moses Akinmuyiwa; 2008, Print Nadar, E. Narayanan. Money and Banking. PHI Learning pvt. ltd. ; 2013. Print.