Chapter 14

CHAPTER 14
REVISION MEMO
THEORY REVISION MEMO:
1. They are: formulation and implementation of monetary policy, service to the government,
provision of economic and statistical services and maintaining financial stability. (Discussed on page
261-262 of the textbook)
2. The main determinants are income and interest rates. The demand for active balances, that is, the
demand for money for transactions purposes (related to the function of money as a medium of
exchange) is positively related to income. The higher the level of income, the greater the value of
transactions entered into and therefore the greater the quantity of money demanded (for
transactions purposes). In other words, the larger the economy becomes, the greater the value of
the transactions and the greater the quantity of money required for transactions purposes.
The demand for passive balances, that is, the demand for money for speculative purposes (related
to the function of money as a store of value) is related to the current and expected level of interest
rates. For example, if interest rates are high, the opportunity cost of holding money (which earns
little or no interest) is high and the quantity of money demanded for speculative purposes will be
low (ceteris paribus). There is thus an inverse relationship between interest rates and the quantity
of money demanded for speculative purposes. This relationship tends to be strengthened if the
expected level of interest rates is also taken into account.
3. Money is a generally accepted medium of exchange or means of payment. If I want to purchase
items, I must pay for the goods or services in question, that is, I need a means of payment or
medium of exchange. I have to provide something in exchange for the goods or services I receive.
In some cases, I may provide other goods and services (as in a barter economy) but in most cases I
provide money. This can take the form of notes and coin, or a transfer of a deposit (e.g.
electronically or by issuing a cheque). As a participant in a money economy, I use money as a
medium of exchange on a daily basis. This is the unique function of money.
Money also serves as a unit of account. Prices, incomes and other important variables are usually
expressed in money terms. This allows me to budget and to manage my expenditure. By expressing
values in money terms, different things may be added together and various types of calculation
may be made. Individuals’ wealth may be calculated and companies’ profits may be estimated.
Money is indeed an important unit of account. It has one drawback, however. Money loses its value
during inflation. Adjustments therefore have to be made for price changes. In particular, nominal
values should be adjusted for inflation to determine what happened to real values. For example, if
I earned R10 000 per month last year and still earn R10 000 per month this year, it does not mean
that I am in the same position as I was last year. Money loses some of its value as a unit of account
when there is inflation.
A third important function of money is that it may serve as a store of value. By this we mean that
you may keep some of your wealth in the form of money. Anyone who possesses wealth has to
decide in which form to hold it. Wealth may be held in a variety of forms, including fixed property,
shares, bonds, savings accounts and Persian carpets. Wealth may also be held in the form of money,
which may easily be exchanged for goods and services. Money, however, loses its value during
inflation and earns little or no interest. Under normal circumstances, I would thus hold most of my
wealth in other forms, rather than money.
Money is indeed a store of value but it is only one of a whole range of possible stores of value. The
essential function of money is still that it serves as a medium of exchange or means of payment
4. To be able to enter into transactions and because they want to keep part of their wealth in the
form of money. The first is called the transactions motive and the second the speculative motive.
The transactions motive is simple to understand. To be able to partake in a money economy, to
enter into transactions, to buy goods and services, you need money (as a means of payment or
medium of exchange). The ultimate purpose is to “spend” the money, which is why it is also called
a demand for active balances.
But some people also hold money over and above the amount they require for transactions
purposes. This is the demand for money as a store of value, or what we call the speculative demand
for money. People keep some of their wealth in the form of money because they believe it is the
correct thing to do. This so-called demand for passive balances is strongly related to the current
and expected level of interest rates.
5. Money, however, is simply a generally accepted means of payment or medium of exchange. Notes
and coin are the most obvious examples, but they constitute a relatively small part of the total
amount of money. In most cases payment is effected by transferring deposits from one person to
another, for example, electronically or by writing out a cheque
MCQ MEMO
1. A
2. C
3. D
4. C
5. C
6. C
7. C
8. B

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