key terms

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exchange rate


monetary union

The most important function of money is to be a medium of exchange.

Imagine trying to obtain an iPhone from the Apple store without money.  You would have to find some sort of way to trade (or barter). You could give the Apple guy 50 loaves of bread in exchange (if you can find a way to trade for the flour and yeast). What if the Apple store does not need 50 loves of bread?  You could offer to work for them, but you probably don’t have the skills they are looking for right off.  Wouldn’t it just be nicer if you could give the Apple guy something that he could take and go to, say Chick-Fil-A, and get what he really wants for that iPhone – a few chicken sandwiches. Money fills that role; it becomes the medium through which exchange occurs. The Apple guy knows that if he takes your money he can go next door or anywhere that he wants and they will accept that money for the goods that he wants!

Assume that a biscuit costs one dollar today.  If the central bank increases the money supply there are more dollars available. With more dollars, people want to buy more biscuits. The baker cannot make any more biscuits so in order to not run out he raises the prices, say to two dollars (too much money following too few goods). The money that you hold cannot buy as many biscuits tomorrow as it could have today. The value of your money has gone down.

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