#AP Macroeconomics: Money and the Money Supply - The Night Before 🚀

Hey! Let's make sure you're feeling super confident for tomorrow's exam. We're going to break down everything about money and the money supply, keep it simple, and make it stick. Let's do this!

#What is Money? 🤔

#Types of Money

• Fiat Money: This is what we mostly use today—paper money and coins. It's money because the government says it is, not because it has any other inherent value. Think of it like a token. 🪙
• Commodity Money: This has value in itself, like gold, silver, or even tobacco in some historical contexts. It's useful even if it's not used as money. 💰

#Functions of Money

These three functions are CRUCIAL. You'll see them in multiple choice and FRQs. Know them inside and out!

#1. Medium of Exchange 🤝

• Money makes transactions easy. Instead of bartering (trading goods directly), you use money to buy what you need. Think of it as a universal 'go-between'.

  

  • Caption: Bartering is inefficient. Money simplifies transactions.

#2. Unit of Account 📏

• Money provides a common way to measure value. It's how we know a diamond is worth more than a pencil. Prices are the key here. It's like a universal measuring stick for value.

  

  • Caption: Money allows us to compare the value of different goods and services.

#3. Store of Value 🏦

• Money holds its value over time (mostly). You can save it and it won't lose its worth immediately. Unlike cookies, money doesn't go stale. 🍪➡️ 💰

  

  • Caption: Money retains its value over time, unlike perishable goods.

#Examples:

• Store of Value: Depositing your paycheck into a savings account. 💰
• Unit of Account: Comparing the price of a name-brand versus a generic product. 🏷️
• Medium of Exchange: Using cash to buy a plane ticket. ✈️

#Measurements of the Money Supply

• Liquidity: How quickly something can be converted into cash.
• Credit Cards: NOT money! They are short-term loans. 💳

#M1 and M2

• M1: = Cash + Coins + Checking Deposits + Traveler's Checks

• M2: = M1 + Savings Deposits + Small Time Deposits + Money Market Deposits + Money Market Mutual Funds

  

  • Caption: M1 is the most liquid form of money, while M2 includes less liquid assets.

• Money Supply: M1 and M2 together. It's the total amount of money available in an economy. The supply curve is vertical because it's fixed at any given time.

#Monetary Base (M0 or MB)

• Monetary Base: Physical currency in circulation + bank reserves. It's the base upon which the money supply is built.

• NOT part of the money supply. It's the final settlement of transactions.

  

  • Caption: Monetary base is the foundation of the money supply, but not part of it.

Monetary base is NOT part of the money supply

#Final Exam Focus 🎯

Focus on the functions of money, the definitions of M1 and M2, and the difference between the monetary base and the money supply. These are frequently tested concepts.

• High-Priority Topics:
  • Functions of money (medium of exchange, unit of account, store of value).
  • Definitions of M1 and M2. * Understanding the monetary base and its relationship to the money supply.
  • Liquidity and its importance.
• Common Question Types:
  • Multiple-choice questions testing definitions and concepts.
  • FRQs requiring you to apply these concepts to real-world scenarios.
• Last-Minute Tips:
  • Time Management: Don't spend too long on any one question. Move on and come back if you have time.
  • Common Pitfalls: Don't confuse monetary base with the money supply. Remember credit cards are not money.
  • Strategies: Read questions carefully and underline key terms. Use your knowledge of the concepts to eliminate incorrect answers.

#Practice Questions 📝

Practice Question

#Multiple Choice Questions

1. Which of the following is the BEST example of money serving as a unit of account? (A) Using a dollar bill to purchase a cup of coffee. (B) Comparing the price of two different brands of cereal. (C) Saving money in a bank account for future use. (D) Trading a goat for a lamb. (E) Using a credit card to pay off debt.

2. Which of the following is included in M2 but not in M1? (A) Cash in circulation (B) Checking account deposits (C) Traveler's checks (D) Savings deposits (E) Coins

3. The monetary base includes which of the following? (A) Credit card balances (B) Savings deposits (C) Checking deposits (D) Physical currency in circulation (E) Money market mutual funds

#Free Response Question

Assume the economy is in a recession. The central bank is considering different monetary policy actions.

(a) Define the monetary base and explain how it differs from the money supply. (2 points)

(b) Identify and explain the three functions of money. (3 points)

(c) Suppose the central bank decides to increase the money supply. Describe one action the central bank could take to achieve this goal. Explain how this action would affect the monetary base and the money supply. (3 points)

#FRQ Scoring Guide:

(a) Define the monetary base and explain how it differs from the money supply. (2 points)

• 1 point: For a correct definition of the monetary base as the sum of physical currency in circulation and bank reserves.
• 1 point: For explaining that the monetary base is not part of the money supply, but serves as the base upon which the money supply is built.

(b) Identify and explain the three functions of money. (3 points)

• 1 point: For identifying the medium of exchange function and explaining that money facilitates transactions without the need for bartering.
• 1 point: For identifying the unit of account function and explaining that money provides a common measure of value.
• 1 point: For identifying the store of value function and explaining that money can hold its value over time.

(c) Suppose the central bank decides to increase the money supply. Describe one action the central bank could take to achieve this goal. Explain how this action would affect the monetary base and the money supply. (3 points)

• 1 point: For correctly identifying an action the central bank could take, such as buying government bonds (open market purchase).
• 1 point: For explaining that this action would increase the monetary base by injecting more reserves into the banking system.
• 1 point: For explaining that this action would also increase the money supply through the money multiplier effect.

You've got this! You're well-prepared, and you're going to do great. Remember to stay calm, trust your knowledge, and tackle each question strategically. Good luck! 🍀