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What are the three basic functions of money?
ECO401 How to calculate Marginal Rate of Substitution (MRS) using indifference curves
ECO401 Total and Marginal utility curves
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What are the three basic functions of money? Discuss how rapid inflation can undermine money’s ability to perform each of the three functions, giving examples when possible.
The three basic function of money are first a medium of exchange, second store of value, and third a unit of account. The first a medium of exchange is probably the most important this is where you use money for the buying and selling of services and is more reliable than any other form of receiving and selling of goods. Second a store of value this is when you take some of your money and put it away in a bank or invest it in the stock market to make a return on your money so your are storing your money in hopes of getting value back out of it. Then third is unit of account this is used to determine the value of goods and services then on the other hand it is use to calculate debt obligation. This is one thing that is used by the government in determining the nations GDP.
Inflation affects these three functions because as prices increase the buying power of the dollar is decreasing to these acts badly on the three functions. That is why darning the recession we are in people started investing their money in gold because it is not affected by inflation like the dollar is. That is why as bad as the economy has gotten in this recession the price of gold still continued to rise because so many people stopped putting their money into banks and started putting it into gold.
Money is any good that is widely accepted in exchange of goods and services, as well as payment of debts. Most people will confuse the definition of money with other things, like income, wealth, and credit. Three functions of money are
1. Medium of exchange: Money can be used for buying and selling goods and services. If there were no money, goods would have to be exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the basis of mutual need). For example: If I raise chickens and want to buy cows, I would have to find a person who is willing to sell his cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of the double coincidence of wants.
2. Unit of account: Money is the common standard for measuring relative worth of goods and service.
3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be spent to buy goods and services). Money’s value can be retained over time. It is a convenient way to store wealth.
Factors of production are various types of resources used in the production ofgoods and services. They are:
Income from exploiting the 3 production factors comprises the national income.
Capital and labor are active factors while land is passive. One can only shift capital and labor rather than land which is given limited, to get a production-factor combination, which is further reflected in the technology a firm employs to produce products and services.
Labor operates capital to produce. The ratio of labor over capital is a major decision almost all firms must make. In the decision process, decision makers must understand that neither too much labor per unit of capital nor too much capital per unit of labor is acceptable since either way efficiency is not achieved. The 2 factors must come around someplace that both of them contribute equally to the final economic value realized.
How to calculate Marginal Rate of Substitution (MRS) using indifference curves
Suppose a person is willing to give up 20 units of good A (on the vertical axis) for 10 units of good B (on the horizontal axis), and his level of satisfaction is unchanged, the marginal rate of substitution is:
MRS = 20/10= 2
Marginal utility functions can also be derived using calculus:
TU = 60Q – 4Q2
This is quadratic utility function.
To find out marginal utility, we take derivative of TU function:
MU = dTU/ dQ = 60-8Q
For calculating MU,
we take different values of Q.