Economics Micro & Macro (CliffsAP)

Part II: Macroeconomics

You should be aware of two types of money for the AP exam:

■ Fiat money:Money that is decreed by the government as an acceptable means of exchange for goods and services.

■ Commodity money:Money that has intrinsic value (in other words, it’s worth its weight in a precious metal).

Gold, silver, and any other precious metal is considered commodity money.

The Money Supply

The quantity of money available for the public is a key determinant in many economic variables because changes in the
money supply affect interest rates, inflation, consumption, and savings. Not all money is considered a part of the money
supply. When economists measure the money supply, they measure spendableassets.

Distinguishing between spendable assets has become a problem for economists. To remedy this problem, economists
have come up with several definitions of the money supply:

■ M1 (the most liquid form of the money supply)

■ All currency in the hands of the public (paper money and coins)

■ All checkable deposits in commercial banks

■ Travelers checks

M1 is the most common form of the money supply. Consumers can use M1 for direct transactions and instant exchange
for goods and services.

M2 encompasses M1 along with the following types of money:

■ Savings deposits

■ Certificates of deposit ($100,000 or less)

■ Money market mutual funds

While the components of M1 are the most liquid assets, M2 includes M1 and less liquid assets. In other words:

M2 = M1 + saving deposits, CDs ($100,000 or less), and money market mutual funds

Finally, M3 consists of M1, M2, and large-time deposits (certificates of deposits) of over $100,000:

M3 = M2 + large-time deposits

Businesses usually own large-time deposits, which are used for future investments.

You may be wondering what backs the money supply. Long ago, the U.S. Federal Reserve backed the money supply
with gold. Today, because of impracticalities (such as the size of the population and the amount of money in circula-
tion), the U.S. money supply is no longer backed by gold. You may be surprised to learn that the only thing that backs
the money supply is the federal government’s promise to keep its value stable.

For the AP exam, it is important to remember that paper money issued by the Federal Reserve banks is debt belonging
to the Federal Reserve. The paper money acts as a promissory note of the Fed to be exchanged for goods and services.
Checkable depositsare the debt of commercial banks, which are responsible for upholding the value of checkable
deposits.

Three factors give money its value:

■ Acceptability:Money is money because people accept it as value. When you present money in exchange for a

good or service, you can feel confident that it will be accepted.