LESSON 4. FINANCES IN A MARKET ECONOMY
Discussion
Explain what the following proverbs mean. Choose one of them and enlarge on it: say whether you agree or disagree with what it says. Support your point of view with reasons and examples from your reading, your observations or your own life experience.
1. Take care of the pence and the pounds will take care of themselves.
2. A fool and his money are soon parted.
3. Money is a good servant, but a bad master.
4. Money is the root of all evil.
5. Money makes money.
6. The best things in life are free.
1. Read the text below, define its main idea.
TEXT 1. MONEY AND ITS FUNCTIONS
Although the crucial feature ofmoney is its acceptance as the means of payment or medium of exchange, money has other functions. It serves as a standard of value, a unit of account, a store of value and as a standard of deferred payment. Let’s discuss each of the functions of money in turn.
The Medium of Exchange
Money, the medium of exchange, is used in one half of almost all exchange. Workers exchange labour services for money. People buy and sell goods in exchange for money. We accept money not to consume it directly but because it can subsequently be used to buy things we do wish to consume. Money is the medium through which people exchange goods and services.
To see that society benefits from a medium of exchange, imagine a barter economy. A barter economy has no medium of exchange. Goods are traded directly or swapped for other goods.
In a barter economy, the seller and the buyer each must want something the other has to offer. Each person is simultaneously a seller and a buyer. In order to see a film, you must hand over in exchange a good or service that the cinema manager wants. There has to be a double coincidence of wants. You have to find a cinema where the manager wants what you have to offer in exchange.
Trading is very expensive in a barter economy. People must spend a lot of time and effort finding others with whom they can make mutually satisfactory swaps. Since time and effort are scarce resources, a barter economy is wasteful. The use of money – any commodity generally accepted in payment for goods, services, and debts – makes the trading process simpler and more efficient.
Other Functions of Money
Money can also serve asa standard of value. Society considers it convenient to use a monetary unit to determine relative costs of different goods and services. In this function money appears asthe unit of account, it is the unit in which prices are quoted and accounts are kept.
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In Russia prices are quoted in roubles; in Britain, in pounds sterling; in the USA, in US dollars. It is usually convenient to use the units in which the medium of exchange is measured as the unit of account as well.
Money isa store of value because it can be used to make purchases in the future. To be accepted in exchange, money has to be a store of value. Nobody would accept money as payment for goods supplied today if the money was going to be worthless when they tried to buy goods with it tomorrow. But money is neither the only nor necessarily the best store of value. Houses, stamp collections, and interest-bearing bank accounts all serve as stores of value. Since money pays no interest and its real purchasing power is eroded by inflation, there are almost certainly better ways to store value.
Finally, money servesas a standard of deferred payment or a unit of account over time. When you borrow, the amount to be repaid next year is measured in pounds sterling or in some other hard currency. Although convenient, this is not an essential function of money. UK citizens can get bank loans specifying in dollars the amount that must be repaid next year.
Thus, the key feature of money is its use as a medium of exchange. For this, it must act as a store of value as well. And it is usually, though not invariably, convenient to make money the unit of account and standard of deferred payment as well.
Different Kinds of Money
A token money is a means of payment whose value or purchasing power as money greatly exceeds its cost of production or value in uses other than as money.
A $10 note is worth far more as money than as a 3x6 inch piece of high-quality paper. Similarly, the monetary value of most coins exceeds the amount you would get by melting them down and selling off the metals they contain. By collectively agreeing to use token money, society economizes on the scarce resources required to produce money as a medium of exchange.
In modern economies, token money is supplemented by IOU money.
An IOU money is a medium of exchange based on the debt of a private firm or individual.
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A bank deposit is IOU money because it is a debt of the bank. When you have a bank deposit the bank owes you money. You can write a cheque to yourself or a third party and the bank is obliged to pay whenever the cheque is presented. Bank deposits are a medium of exchange because they are generally accepted as payment.
Modern banking
An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary such as a bank, or buy bonds in the bond market. The interest rate for the borrowers is higher than that for the lender, and the financial intermediary earns the difference for arranging the loan, which is called its rate of return.
A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays interest. The bank then lends these deposits to borrowers. The deposit is a liability of the bank, i.e. it is money owed to depositors. Banks allow borrowers and lenders of different sizes (such as households, firms or governments) to coordinate their activity.
Commercial banks are financial intermediaries with a government licence to make loans and issue deposits, including deposits against which cheques can be written.
Banks are not the only financial intermediaries. Insurance companies, pension funds, and building societies also take in money in order to relend it. The crucial feature of banks is that some of their liabilities are used as a means of payment, and are therefore part of the money stock
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