ECON 201 1st Edition Lecture 20Outline of Last Lecture I. Information, Risk, and Insurancea. Definition of imperfect informationb. Definition of asymmetric information c. Definition of adverse selectionII. Moral Hazarda. Definition of moral hazardIII. Policy ImplicationsIV. The Government and Social InsuranceOutline of Current Lecture I. Money and Its Functions in an Economya. Definition of moneyb. Definition of medium of exchangec. Definition of unit of accountd. Definition of store of valuee. Definition of standard of deferred paymentII. Types of Moneya. Definition of commodity moneyb. Definition of representative commodity moneyc. Definition of fiat moneyIII. The Money Supplya. Definition of money supply/money stockb. Definition of currencyc. Definition of demand deposits/checkable depositsd. Definition of M1e. Definition of M2IV. The Banking Systema. Definition of fractional reserve banking systemb. Definition of reserve requirementsc. Definition of reserve ratio/RCurrent LectureThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.I. Money and Its Functions in an EconomyDo we need money to survive? The simple answer is “no”; money in and of itself is not a necessity. Previous societies have worked without money by using barter systems, where people exchange goods for other goods they want. However, this system only works when thereis a double coincidence of wants; if one person doesn’t want to exchange goods with another then it will not lead to an efficient economy. This is where money comes into play. Money is an intermediate good that people use to buy goods and services from other people. Money reduces the search time it would take to exchange goods in a barter system and doesn’t waste resources. Money has three main functions in an economy: that of a medium of exchange, a unit of account, and a store of value. A medium of exchange is an item buyers give to sellers when they want to purchase goods and service. This is the most common function of money in the market. It also acts as a unit of account, which is the “yardstick” that people use to post prices and record debts. Finally, it functions as a store of value, an item that people can use to transfer purchasing power from the present to the future. Some economists also consider money to function as a standard of deferred payment. A standard of deferred payment is an item used not only as a medium of exchange today, but also to purchase today and pay for it in the future. For the purpose of this class, we will focus on the three aforementioned functions ofmoney. II. Types of MoneyThere are three different types of money in an economy: commodity money, representative commodity money, and fiat money. Commodity money is money that is a commodity but also has intrinsic value. An example of this is gold; gold was used as a form of payment in the past primarily because it had intrinsic qualities that made it invaluable to the economy. Gold does not ruin if it gets wet, does not rust, is essentially fireproof, will not be consumed or will not rot.Having a commodity money that has these characteristics was useful in past time periods. Representative commodity money is money that represents a commodity; an example of this isthe U.S. dollar from 1945-1973 or a gold exchange. Representative commodity money arose because of the biggest problem with commodity money: there is not enough of it. There is a limited amount of gold in the world, so if an economy relies solely on commodity money they are very limited in economic growth. This problem occurred in the U.S. in the 20th century due to the growing economy; to respond to this, the U.S. devalued the dollar during 1945-1973. Though it worked for a short period of time, ultimately the U.S. ended up converting the U.S. dollar from a representative commodity money to fiat money. Fiat money is money without intrinsic value, used as money because of a government decree. An example of this is the current U.S. dollar we have now. However, the problem with fiat money is that if the government issues money and the people do not believe in the new system of money, then it is not of value. III. The Money SupplyThe money supply, or money stock, is the quantity of money available in an economy. Both currency and demand deposits are considered part of the money supply. Currency is the paper bills and coins in the hands of the (non-bank) public. Demand deposits, or checkable deposits, are balances in bank accounts that depositors can access on demand by writing a check. There are two measures of the U.S. money supply: M1 and M2. M1 is the first measure and includes currency, demand deposits, and traveler’s checks as the money supply. The current value of M1 in the United States is approximately $2.8 million. M2 is the second measure supply and includes everything in M1 along with savings deposits, small time deposits, money market deposits, money market mutual funds, certificates of deposits, and other time deposits. The current value of M2 in the United States is approximately $11.4 trillion. IV. The Banking SystemBanks act as intermediaries between savers and borrowers. Savers give money to banks throughdeposits and take money from banks by means of withdrawals and interest payments from the banks. Borrowers take money from banks by means of loans and give money to banks through the repayment of loans and interest payments to the banks. In the process of exchanging moneybetween savers and borrowers, banks create money. They do this by using a fractional reserve banking system, which is a system where banks keep a fraction of deposits as reserves and use the rest to make loans. This is based on the goldsmith’s principle. A goldsmith used to hold gold for people and keep it safe; however, goldsmiths quickly realized that the majority of gold was not being used each day but staying in the safe. They understood that they could make extra profit by loaning the gold they had to others and accruing interest on the loans. This is the sameprinciple with fractional reserve banking systems. However, banks cannot give money as they please: the Federal Reserve (Fed) sets reserve requirements, or regulations on the minimum amount of reserves that banks must hold against deposits. The Fed has a vault of cash and deposits that banks can access and the vault works as a tool of monetary