CHAPTER 1:
AN OVERVIEW OF MONEY AND
FINANCE
Dr: Phuong Nguyen
Content
The Nature and Functions of Money
Exploring what money is, how it works, and why it matters in our economic system
The Evolution of the Payments System
Tracing the development from barter to digital currencies
Measuring Money: The Money Aggregates
Understanding how economists quantify and categorize money
The Essence of Finance
Defining finance and its fundamental principles
The Functions of Finance
Examining how finance operates in business and personal contexts
What is Money?
"Anything that is generally accepted in payment for goods or
services or in the repayment of debts."
- Frederic S. Mishkin
Discussion Questions: "Money and Happiness"
Would you rather cry in a luxury car or smile on a bicycle?
Would you choose a job that pays double your dream job but makes you
miserable?
"Create a short personal meme or slogan that reflects your opinion about money and happiness."
Money in Our Lives
"Money can't buy happiness, but it will certainly get you a better class of
memories."
- Ronald Reagan
"Money can't buy happiness, but neither can poverty."
- Leo Rosten
While not the source of happiness itself, money provides access to experiences,
security, and opportunities that can significantly enhance our quality of life.
Distinguishing Money from Related Concepts
Money Currency/Cash
Anything generally accepted as payment for goods/services or debt Physical paper notes and coins. Just one form of money, but not the
repayment. only one. Increasingly represents a smaller portion of the total money
supply.
Wealth Income
The total collection of properties that store value. Money is just one A flow concept representing earnings per unit of time. Money
component of wealth, which can include real estate, investments, received regularly from work, investments, or other sources.
and other assets.
Understanding these distinctions helps clarify economic discussions and personal financial planning. Money itself is just one element in a broader
financial ecosystem.
The Barter Economy
Before the invention of money, economies operated on
barter - the direct exchange of goods and services
without using a medium of exchange.
Required a "double coincidence of needs" - both
parties needed to want what the other offered
Difficult to divide certain goods (how do you trade
half a cow?)
No standard measure of value made fair trades
challenging
Impossible to store value effectively for future use
Limited specialization and economic growth
The Functions of Money
Medium of Exchange
The most fundamental function of money is serving as a medium of
exchange. This function:
Eliminates the need for a double coincidence of needs
Dramatically reduces transaction costs
Promotes specialization and division of labor
Enables complex economic systems to function
For an item to function effectively as a medium of exchange, it must be:
Easily standardized
Widely accepted
Divisible into smaller units
Portable and easy to carry
Durable and resistant to deterioration
As a medium of exchange, money facilitates countless transactions
daily, from small retail purchases to massive international trades, without
requiring direct barter.
The Functions of Money: Unit of Account and Store of
Value
Unit of Account Store of Value
Money serves as a standard numerical unit for measuring the Money allows purchasing power to be preserved for future use. As
market value of goods and services. This function: a store of value:
Provides a common measure for comparing values of different Enables saving and deferred consumption
goods Bridges the gap between income and expenditure
Makes accounting and economic calculation possible Provides liquidity for unexpected needs
Reduces transaction costs by simplifying price comparisons Competes with other assets (stocks, real estate) that also store
Enables complex financial planning and analysis value
While other assets may serve as better stores of value over long periods (due to inflation eroding money's purchasing power), money's superior
liquidity makes it uniquely valuable for immediate needs.
Why Hold Money?
Question:
There are many assets to store purchasing power. Why do people still want to hold MONEY?
Liquidity Advantage Certainty of Value
Money is the most liquid asset, immediately available for Unlike stocks or bonds whose values fluctuate, money's nominal
transactions without conversion costs or delays. This makes it value is stable and predictable (though its purchasing power may
invaluable for daily expenses and emergencies. change with inflation).
Transaction Convenience Precautionary Motive
Money minimizes transaction costs compared to other assets that Holding money provides security against unexpected expenses or
require conversion before use in purchases. opportunities that require immediate payment.
Types of Money
Commodity Money Fiat Money
Money that has intrinsic value due to the Paper money and coins declared by
material it is made from: governments as legal tender:
Gold and silver coins Modern currencies (USD, EUR, JPY,
Cigarettes (in prisons or war zones) etc.)
Salt (historically) No intrinsic value beyond its use as
money
Shells, beads, and other valuable
items Value based on government decree
and public confidence
Characteristics:
Characteristics:
Value independent of its use as
money Not backed by physical commodities
Limited by physical supply Supply controlled by central banks
Relatively stable value Value can fluctuate with economic
conditions
Evolution of the Payments System
Barter Economy 1
Direct exchange of goods and services without using money.
Limited by the double coincidence of needs problem.
2 Commodity Money
Use of valuable items like gold, silver, shells as standardized
exchange mediums with intrinsic value.
Metallic Standards 3
Currencies backed by precious metals, with fixed conversion
rates to gold or silver.
4 Paper Currency
Initially as receipts for deposited metals, eventually evolving into
fiat money backed by government decree.
Electronic Payments 5
Digital transfers, credit/debit cards, and online payment
systems reducing physical currency use.
Modern Payment Methods
Checks Debit Cards Credit Cards
Written instructions to a bank to transfer Cards that directly access funds in the Cards that allow purchases on credit, to be
money from the drawer's account to the cardholder's bank account, providing repaid later, often with interest if not paid in
recipient. Though declining in use, checks immediate payment at point of sale. full.
remain important for certain transactions.
Immediate withdrawal from account Provides short-term financing
Provides paper record of payment Widely accepted globally Often includes rewards programs
Can be mailed for remote payments Reduces need to carry cash Builds credit history
Delayed processing compared to
electronic methods
These payment methods represent the evolution from physical to electronic money, each with distinct advantages for different transaction types.
Are We Headed for a Cashless Society?
Despite decades of predictions about the imminent
YouTube
arrival of a cashless society, physical currency persists Sweden: How to live in the world's first c&
alongside electronic payment methods. But several Cashless societies offer many advantages. In
addition to the convenience that not having to&
factors work against the complete disappearance of
cash. 05:03
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What does a cashless future mean?
Many countries are going cashless at great
speed. What are the advantages of ditching&
05:22
Measuring Money: The Money Aggregates
Economists measure money through increasingly broad aggregates based on liquidity - how easily assets can be used for transactions.
M1 - Most Liquid Money M2 - Broader Money Supply
M1 includes the most liquid forms of money: M2 includes M1 plus less liquid forms of money:
Currency in circulation Small-denomination time deposits
Traveler's checks Savings deposits
Demand deposits (checking accounts) Money market deposit accounts (MMDA)
Other checkable deposits Retail money market mutual fund shares
These assets can be immediately used for transactions without These assets require some conversion before use in transactions.
conversion.
These aggregates help central banks monitor and manage the money supply to implement monetary policy effectively.
Money Aggregates in Numbers
Measures of the Monetary Aggregates Value as of May 16, 2011 ($ billions)
M1 Components:
Currency 958.8
Traveler's checks 4.6
Demand deposits 573.1
Other checkable deposits 399.0
Total M1 1,935.5
Additional M2 Components:
Small-denomination time deposits 848.3
Savings deposits and money market deposit accounts 5,530.4
Money market mutual fund shares (retail) 688.4
Total M2 9,002.6
This table illustrates the composition of money aggregates in the U.S. economy. Note that M2 is substantially larger than M1, reflecting the significant
volume of near-money assets in the financial system. The largest component of M2 is savings deposits and money market deposit accounts,
highlighting the importance of these instruments in the broader money supply.
The Essence of Finance
Finance is a term for matters regarding the management, creation, and study of
money and investments. It involves the use of credit and debt, securities, and
investment to finance current projects using future income flows.
Finance serves as the backbone of economic activity, providing the mechanisms
through which capital is allocated, risks are managed, and economic value is created
and preserved. It connects those with surplus funds to those who need capital for
productive purposes, enabling economic growth and development.
At its core, finance is about making decisions regarding money under conditions of
uncertainty and across time. These decisions shape everything from individual
retirement plans to global economic systems.
Types of Finance
Corporate Finance
Deals with financial decisions made by
businesses:
Capital investment decisions
Public Finance Financing strategies
Focuses on government revenue, Dividend policies
expenditure, and debt management:
Working capital management
Taxation policies
Government budgeting Personal Finance
Public debt management Concerns individual and household financial
decisions:
Fiscal policy implementation
Budgeting and saving
Investment planning
Retirement preparation
Risk management through insurance
These three domains of finance are interconnected, with developments in one area often affecting the others. Together, they form a comprehensive
framework for understanding financial activities at all levels of the economy.
Financial Freedom
Financial freedom represents a state where individuals have sufficient
passive income to cover their living expenses, eliminating the need to
work for money. It's characterized by:
Financial freedom provides the autonomy to make life choices based on
Having enough savings, investments, and cash to afford the lifestyle personal values and goals rather than monetary constraints.
you want
Not being constrained by debt or financial obligations
Having the flexibility to make choices based on personal preferences
rather than financial necessity
Being prepared for financial emergencies without stress
Having the ability to pursue opportunities without financial
constraints
Financial freedom isn't necessarily about being wealthy in the traditional
sense, but rather about having control over your financial life and the
choices it enables.
The Functions of Finance
The finance function encompasses practices and activities directed toward managing business finances. These functions are oriented toward
acquiring and managing financial resources to generate profit.
Financial Planning Funding and Capital Raising
Establishing financial goals and developing strategies to achieve them Securing necessary financial resources through debt, equity, or
through budgeting, forecasting, and resource allocation. internal cash flows to support operations and growth.
Investment Management Risk Management
Allocating financial resources to assets and projects that generate Identifying, assessing, and mitigating financial risks through
returns while managing associated risks. diversification, insurance, and hedging strategies.
These functions work together to optimize financial performance, create value, and ensure long-term sustainability for businesses and individuals
alike.
Key Takeaways: Money and
Finance
1 2 3
Core Functions of Types of Money Finance Categories
Money Commodity money with Public, corporate, and
Medium of exchange, unit intrinsic value and fiat personal finance provide
of account, and store of money backed by frameworks for
value - these three government decree understanding financial
functions make money represent the main forms activities at different levels
essential to economic of money throughout of the economy.
activity. history.
4
Finance Functions
Planning, funding,
investment, and risk
management constitute
the core functions that
drive financial decision-
making.
Understanding these fundamental concepts of money and finance provides a
foundation for making informed financial decisions, whether as individuals managing
personal finances or as professionals in business and economic policy.
