Economic terms and definitions pdf

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economic terms and definitions pdf

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24.1 What Is Money?

If cigarettes and mackerel can be used as money, then just what is money? Money is anything that serves as a medium of exchange. A medium of exchange is anything that is widely accepted as a means of payment. In Romania under Communist Party rule in the s, for example, Kent cigarettes served as a medium of exchange; the fact that they could be exchanged for other goods and services made them money.

Money, ultimately, is defined by people and what they do. When people use something as a medium of exchange, it becomes money. If people were to begin accepting basketballs as payment for most goods and services, basketballs would be money.

We will learn in this chapter that changes in the way people use money have created new types of money and changed the way money is measured in recent decades. Money serves three basic functions. By definition, it is a medium of exchange. The exchange of goods and services in markets is among the most universal activities of human life. To facilitate these exchanges, people settle on something that will serve as a medium of exchange—they select something to be money.

We can understand the significance of a medium of exchange by considering its absence. Barter occurs when goods are exchanged directly for other goods.

Because no one item serves as a medium of exchange in a barter economy, potential buyers must find things that individual sellers will accept. A buyer might find a seller who will trade a pair of shoes for two chickens. Another seller might be willing to provide a haircut in exchange for a garden hose. Suppose you were visiting a grocery store in a barter economy. You would need to load up a truckful of items the grocer might accept in exchange for groceries.

That would be an uncertain affair; you could not know when you headed for the store which items the grocer might agree to trade. Indeed, the complexity—and cost—of a visit to a grocery store in a barter economy would be so great that there probably would not be any grocery stores! One is that people do not arrive at places like Radio Shack with five pizzas and expect to purchase a radio. The other is that the information would not be very useful. Other people may not think of values in pizza terms, so they might not know what we meant.

Instead, we report the value of things in terms of money. Money serves as a unit of account , which is a consistent means of measuring the value of things.

We use money in this fashion because it is also a medium of exchange. When we report the value of a good or service in units of money, we are reporting what another person is likely to have to pay to obtain that good or service.

The third function of money is to serve as a store of value , that is, an item that holds value over time. When you find it, you will be pleased. That is because you know the bill still has value. Money, of course, is not the only thing that stores value. Houses, office buildings, land, works of art, and many other commodities serve as a means of storing wealth and value. Money differs from these other stores of value by being readily exchangeable for other commodities.

Its role as a medium of exchange makes it a convenient store of value. Because money acts as a store of value, it can be used as a standard for future payments.

When you borrow money, for example, you typically sign a contract pledging to make a series of future payments to settle the debt. These payments will be made using money, because money acts as a store of value.

Money is not a risk-free store of value, however. We saw in the chapter that introduced the concept of inflation that inflation reduces the value of money. In periods of rapid inflation, people may not want to rely on money as a store of value, and they may turn to commodities such as land or gold instead. Although money can take an extraordinary variety of forms, there are really only two types of money: money that has intrinsic value and money that does not have intrinsic value.

Commodity money is money that has value apart from its use as money. Mackerel in federal prisons is an example of commodity money. Mackerel could be used to buy services from other prisoners; they could also be eaten. Gold and silver are the most widely used forms of commodity money. Gold and silver can be used as jewelry and for some industrial and medicinal purposes, so they have value apart from their use as money.

The first known use of gold and silver coins was in the Greek city-state of Lydia in the beginning of the seventh century B.

The coins were fashioned from electrum, a natural mixture of gold and silver. One disadvantage of commodity money is that its quantity can fluctuate erratically.

Gold, for example, was one form of money in the United States in the 19th century. Gold discoveries in California and later in Alaska sent the quantity of money soaring. A much greater problem exists with commodity money that can be produced. In the southern part of colonial America, for example, tobacco served as money. There was a continuing problem of farmers increasing the quantity of money by growing more tobacco. The problem was sufficiently serious that vigilante squads were organized.

They roamed the countryside burning tobacco fields in an effort to keep the quantity of tobacco, hence money, under control. Remarkably, these squads sought to control the money supply by burning tobacco grown by other farmers. Another problem is that commodity money may vary in quality. Given that variability, there is a tendency for lower-quality commodities to drive higher-quality commodities out of circulation. Horses, for example, served as money in colonial New England. It was common for loan obligations to be stated in terms of a quantity of horses to be paid back.

Given such obligations, there was a tendency to use lower-quality horses to pay back debts; higher-quality horses were kept out of circulation for other uses. Laws were passed forbidding the use of lame horses in the payment of debts. Unless a means can be found to control the quality of commodity money, the tendency for that quality to decline can threaten its acceptability as a medium of exchange.

But something need not have intrinsic value to serve as money. Fiat money is money that some authority, generally a government, has ordered to be accepted as a medium of exchange. The currency —paper money and coins—used in the United States today is fiat money; it has no value other than its use as money.

They can be converted to currency, but generally they are not; they simply serve as a medium of exchange. If you want to buy something, you can often pay with a check or a debit card. A check is a written order to a bank to transfer ownership of a checkable deposit. A debit card is the electronic equivalent of a check. Notice that it is the checkable deposit, not the check or debit card, that is money. The check or debit card just tells a bank to transfer money, in this case checkable deposits, from one account to another.

What makes something money is really found in its acceptability, not in whether or not it has intrinsic value or whether or not a government has declared it as such. For example, fiat money tends to be accepted so long as too much of it is not printed too quickly. When that happens, as it did in Russia in the s, people tend to look for other items to serve as money.

In the case of Russia, the U. The term money , as used by economists and throughout this book, has the very specific definition given in the text. People can hold assets in a variety of forms, from works of art to stock certificates to currency or checking account balances.

The total quantity of money in the economy at any one time is called the money supply. Economists measure the money supply because it affects economic activity. What should be included in the money supply? We want to include as part of the money supply those things that serve as media of exchange. However, the items that provide this function have varied over time.

Currency serves the medium-of-exchange function very nicely but denies people any interest earnings. Checking accounts did not earn interest before Over the last few decades, especially as a result of high interest rates and high inflation in the late s, people sought and found ways of holding their financial assets in ways that earn interest and that can easily be converted to money.

For example, it is now possible to transfer money from your savings account to your checking account using an automated teller machine ATM , and then to withdraw cash from your checking account. Thus, many types of savings accounts are easily converted into currency.

Checkable deposits are almost perfectly liquid; you can easily cash a check or visit an ATM. An office building, however, is highly illiquid. It can be converted to money only by selling it, a time-consuming and costly process. As financial assets other than checkable deposits have become more liquid, economists have had to develop broader measures of money that would correspond to economic activity.

In the United States, the final arbiter of what is and what is not measured as money is the Federal Reserve System. Because it is difficult to determine what and what not to measure as money, the Fed reports several different measures of money, including M1 and M2.

M2 is a broader measure of the money supply than M1. M2 is sometimes called the broadly defined money supply, while M1 is the narrowly defined money supply. The assets in M1 may be regarded as perfectly liquid; the assets in M2 are highly liquid, but somewhat less liquid than the assets in M1.

Important Economic Terms and Concepts – Definitions & Explanations PDF

If cigarettes and mackerel can be used as money, then just what is money? Money is anything that serves as a medium of exchange. A medium of exchange is anything that is widely accepted as a means of payment. In Romania under Communist Party rule in the s, for example, Kent cigarettes served as a medium of exchange; the fact that they could be exchanged for other goods and services made them money. Money, ultimately, is defined by people and what they do. When people use something as a medium of exchange, it becomes money.


Italicized terms within the definitions are themselves defined Accelerator, Investment: Investment spending stimulates economic growth, which in turn.


Economy Terms and Definitions

We suggest you save this as a PDF and use it as a handy guide for your preparation. Adam Smith: A Scottish Economist, author and a moral philosopher. Average revenue: Refers to the revenue received for selling a good per unit of output sold.

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Economic growth is an increase in the production of goods and services over a specific period. To be most accurate, the measurement must remove the effects of inflation. Economic growth creates more profit for businesses.

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