Birks – Mankiw Chapter 29: The Monetary System
Mankiw, N. G. (2015) Principles of economics (7th ed.) Ch.29
Principles of macroeconomics (7th ed.) Ch.16
Mason, OH: South-Western Cengage Learning
The Monetary System
When reading the chapter, here are some aspects to consider:
1. Mankiw describes barter on p.324, including in the requirement of a double coincidence of wants. Money makes trade easier, but we should not assume that it is universally the best way to exchange. Consider dating. It would be much easier if we could accept payment to on a date with someone who wanted to go out with us, then use the money to pay someone else to go on a date with us, but the nature of the transaction is then fundamentally different. There are good reasons why we do not rely on that system. More generally, the process of exchange can also have a social dimension. This can be missed if we only focus on the product itself. One well known illustration of this point is that of blood donors. People are less willing to give blood when there is some small payment involved compared to when it is freely donated. The payment changes the nature of the transaction (Titmuss, 1970). Consider also the giving of presents. Why don’t we just give money, if that would allow the recipient to purchase whatever gives most utility? Does this indicate the importance of something in addition to utility maximisation based on goods and services?
Note that relationships and marriage are still economic transactions, however, at least when the law on relationship property is applied. It has the unusual characteristic that, given a fixed contribution by the other party, the price paid varies according to a person’s wealth.
2. Some texts include a description of “the characteristics of money”, criteria which must be met for something to work effectively as money. Here, reordered, are six characteristics based on: http://www.slideshare.net/Geckos/uses-and-characteristics-of-money-presentation
You can find more details at the link.
3. An additional function of money is sometimes given, namely a “standard for deferred payments”. Payments in the future are denominated in units of currency – “X will pay Y $500 in 18 months from today”.
4. The money multiplier is 1/R where R is the reserve ratio (given the assumption that only the required reserves are held and all loaned cash is redeposited in a bank).
An easy way to see this is to consider expanding the term 1/(1-x) where 0 < x < 1. I am assuming that you are familiar with long division. If we divide 1 by (1-x), we get 1, with x remaining. If we then divide this x by (1-x), we get x with x2 remaining. We can continue with this process indefinitely to get:
1/(1-x) = 1 + x + x2 + x3 + x4 + x5 + x6 …
What happens to $100 in cash if deposited in a banking system with a reserve ratio, R = 0.1 (10%)? We saw an initial deposit of $100 resulting in a loan of $90 (or $100 x 0.9). This is then redeposited and results in a loan of $81 (or $90 x 0.9, i.e. $100 x (0.9)2) and so on. In other words, we have $100 multiplied by 1, then by 0.9, then by (0.9)2 and so on indefinitely. This is the same as our equation when x = 0.9. The full effect is then $100 x 1/(1-0.9), or $100 x 1/0.1. This is $100 x 1/R.
Titmuss, R. M. (1970). The gift relationship: from human blood to social policy. London: Allen & Unwin.
Commentary by Stuart Birks, 2 September 2014