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Nedith Rachelle L. Rocillo BS Travel Management Explains the role of money in the economic system. the theory of the value of money. Value of money Flow or use of money and not its value – which causes changes in economic activities. Finance Charge A fee charged for the use of credit or the extension of existing credit. interest, fees, service charges discounts, and such other charges incident to the extension of credit Creditor Any person engaged in the business of extending credit who requires as an incident to the extension of credit, the payment of a finance charge. 1. 2. 3. 4. The cash price or delivered price of the property or service to be acquired The amounts, if any, to be credited as down payment and/or trade-in The difference between the amounts set forth under clauses (1) and (2) The charges, individually itemized, which are paid or to be paid by such person in connection with the transaction but which are not incident to the extension of credit 5. 6. 7. The total amount to be financed The finance charge expressed in terms of pesos and centavos; and The percentage that the finance charge bears to the total amount to be financed expressed as a simple annual rate on the outstanding unpaid balance of the obligation. a public authority or But a galloping inflation (about 10 government agency responsible percent increase) becomes disruptive in for exercising autonomous investment, production andconsumption. when prices are authority some area of The Monetary over Board of the Central Bank rising at double or human activityisinauthorized a regulatory or to of of the Philippines by law triple digit rates rules capacity. and regulations as may supervisory 20, 100 or 200 per The worst is astronomical inflation inprescribe cent a year. which the price level increases by 100be necessary to carry out the purposes are corresponding adjustments in percent, 500 percent or even higher. there Regulatory authorities are salaries and pensions. commonly set up to enforce standards and safety, or to oversee use of public goods and regulate commerce. The inflation rate: OCTOBER PERCENT 1983 9.10 1984 63.82 71 out of every 100 families were below the poverty line which was P2,503 a month. is a basic law in economics When demandIt for their products falls, production that when prices increase, subsequentlyquantity slowsdemanded down. This means there will decrease (all other things being be an increase in unemployment. We have to increase the prices of our goods. constant). P D Inflation means higher cost of production. The income theory claims that the use of money can have great influence on economic activities even though its value does not change. Income theorists believe that their theory is better than the money-of-value theories (transactions and cash-balance theory) because it clearly shows how the flow of income or money causes economic changes. Investment, Employment, Production, and Consumption Less Less Less Less production, Employment, Income, and Consumption Income theorists believe that the value-of-money theories were only suitable during the early years when the economy was highly competitive, and when prices were determined by demand and supply forces. States that the value of money (like goods and services) is determined by demand and supply in a given market at a given time. The three determinants of money value are the following: average quantity of money available Average velocity, and The volume of trade S D = P , its value falls D S = P , its value rises It can be stated therefore that other things remaining equal (determinants of the value of money), the general price level varies in direct proportion to the supply of money, and in inverse proportion to the demand for money. PT = MV P is the general price level or average price level paid for goods like rice, shoes, lumber, etc. M is the average quantity of money available throughout the year or other period of time. V is the velocity of money in the same period or the number of times the money is spent in one year. T is the volume of trade, number of transactions or total number of goods, services, and financial instruments that are brought in the market in a given period. To determine the price level, transpose the equation of exchange PT = MV: PT = MV T T P = MV T Supply of Money Demand for Money Price Level = What will be the P? M = 1,000,000; V = 18; and T = 12,000,000 P = MV/T =1, 000, 000(18) 12,000,000 = 18, 000,000 12,000,000 = 1.50 Thus, the equation MV = PT will be: 1,000,000(18) = 1.50 (12,000,000) 18,000,000 = 18,000,000 What will be P? If there is a change on either of the following (other factors remaining the same or constant): M is increased 200,000 Prices will by rise if there is a corresponding V is increased by 6 increase in M or V or decrease in T. T is decreased by 2,000,000 M is decreased by 300,000 will by fall6 if there is a corresponding Prices V is decreased in M or V or increase in T. decrease T is increased by 6,000,000 The answers are as follows: 1. P is 1.80 2. P is 2.00 3. P is 1.80 4. P is 1.05 5. P is 1.00 6. P is 1.00 In a nutshell, the transactions equation explains the interdependencies existing among the quantity of transactions and the level of prices over a period of time. Cash-Balance Theory Transaction Theory • stress the value of money as the main determinant of economic activities. • stress the value of money as the main determinant of economic activities. •Determine the value of money through the demand and supply relationships. •Determine the value of money through the demand and supply relationships. •The supply of money • supply of money refers refers to the cash- to the velocity of money. balances or money holdings of the people. Some reasons why people like to hold cash/retain cash-balance: To be able to buy goods and services in the future. To be able to meet unexpected expenses like accidents or sickness. Business Corporations, on the other hand, maintain cash-balances for financial stability or future investments. Cash-Balance Equation of Exchange: M = KTP M is the average quantity of money available. K is the proportion of the year’s volume of trade over which the The cash-balance equation simply that that, the Followers of the cash-balance theorystates conclude people decide to retain their purchasing power in terms of cashpurchasing power of the available money in the form of other things remaining equal, the general price balances. cash is equal the value of to thethe commodities, level balance varies in directtoproportion supply of and rights. Tservices is the volume of trade, number of transactions totaldemand number money, andproperty in inverse proportion to or the of goods, services, and property rights that are bought in a given for money. period of time. P is the average of goods, services and property rights. P=M KT M = KTP KT KT M KT P = V in the transactions equation and the K in the cash-balance equation, are closely related. Both are determined by exactly the same forces. The velocity of money depends on the decision of owners to spend or save it. Velocity of money becomes greater when people decide to spend their money as fast as they can. Keeping or hoarding money for future purchases, decreases the velocity of money. V and K are reciprocal to each other. IfV is 12, then K is 1/12. What will be P? M = 1,000,000 ; K = 1/6 ; and T = 12,000,000 P = M/KT = 1,000,000 1/6 (12,000,000) = 1,000,000 2,000,000 = .50 Thus, the equation M = PKT will be: 1,000,000 = (.50)(1/6)(12,000,000) 1,000,000 = 1,000,000 What will be P? If there is a change on either of the following (other factors remaining the same or constant): K is increased from 1/6 to 1/3 T is increased from 12,000,000 to 15,000,000 K is decreased from 1/6 to 1/24 T is decreased from 12,000,000 to 6, 000,000 The answers for the above problems are as follows: 1. P is 25 2. P is 40 3. P is 2.00 4. P is 1.00 Summing Prices will it up, risetheifcash-balance there is a corresponding decrease equations relate in K or the T. dependencies among the supply Prices of money, will the fall quantity if there of money, is a corresponding and the demand increase for money in K oratT.a given point of time. Quantity Theory of Money Re-emphasized States that “other things remaining unchanged, a change in the quantity of money will result in proportional changes in the price level”. The quantity theory of money expresses the view that changes in M cannot cause changes in V and T. However, changes in M will result in proportional changes in P. Transaction Equation (MV = PT) MODIFIED FORM: PT = MV + M’V’ M’ refers to the amount of money substitutes (credit instruments), and V’ refers to the velocity (rapidity) of money substitutes. What will be P? P = MV + M’V’ T = 1,000,000 (18) + 1,000,000 (18) 24,000,000 = 36, 000, 000 24,000,000 = 1.50 Quantity theory is a useful tool in understanding long-run monetary and economic problems. Nevertheless, its usefulness in short-run problems of economic and monetary stability is not a remote responsibility. INCOME THEORY Maintains that changes in the economy are not influenced by the changes in the value of money or price levels. The theory stresses the production of new goods, and the speed of spending factor of incomes (wages, rents, interests and profits) for products. It explains the workings of the economic system through the interactions of the various aggregates like investments, income, consumption and savings. The value of money according to the theory is determined by the savings-investment relationship. If S = I, there is no movement in the price level. If S > I, there is a downward pressure on prices. If I > S, there is an upward pressure on prices. Savings – refer to the supply of money and investments to the demand for money. However, the income theorists contend that the changes in prices do not depend only on savings-investment relationships, but also on the availability of the idle factors of production (land, labor, and capital), and the degree of control made by the enterprises in the various fields of the industry. Developed the fundamental equation Y = C + I, where • Y being aggregate income; • C being the amount spent for goods for consumers; • I being the amount spent for, and consequently received in the production of, investment goods (capital) From such a basic equation, other useful equations may be clearly inferred and deduced like: Y – C = S, where • S being the amount of savings left between aggregate income less that amount spent for consumption; Y = C + I; Y = C + S; I = Y – C. Therefore, S = I JOHN MAYNARD KEYNES