THE UNIVERSITY OF ZAMBIA

LECTURE NOTES FOR ECN 3225

MONEY & BANKING

BY TOBIAS MICHELO
BALIS; MScEC
 LECTURE ONE (1)

• 1. Introduction
• Review of money and its functions
• Evolution of payments system

Reference: Mishkin Chapter three

 WHAT IS MONEY?
• In ordinary conversation, we commonly use
the word money to mean income ("he makes a
lot of money") or wealth ("she has a lot of
money").

• Money ( or money supply) refers to anything

that is generally accepted in payment for goods
or services or in the repayment of debts.

• Money is a stock concept. It is a certain

amount at a given point in time.
 Difference with Wealth or Income
• Money is not the same as wealth or income.

• Wealth of a person or nation is the value of assets minus the value of

liabilities owed (to foreigners in the case of a nation) at a point in time.

• The assets include those that are tangible (land, houses, furniture,
cars, arts and capital) and financial (money, stocks, bonds, etc.)

• Wealth serves as a store value. It is a stock concept that is measured at

a given point in time.

• Income refers to the flow of earnings per unit of time

TYPES OF MONEY
• Money consists of the following:
• Currency: The paper notes and coins that people use in a country.
They are money because government declares them so. (legal tender)
• Deposits at banks and other depository institutions are also money.
Deposits are money because they can be converted into currency and because they
are used to settle debts.
Currently, deposits are the largest proportion of money

• Pose Question: Are the following considered as money? (i) Cheques money?
The answer is no. The check is only a way to instruct your bank to transfer money from
your account to another person’s account. However, deposit accounts are money
(ii) credit card considered money? The answer is No. It is not legal tender. What a
credit-card purchases really represents is just an extremely convenient, pre-approved
loan. It's only part of the transaction, since the merchant then goes to the bank that
issued the credit
 Modern market economies
• The development of the history of economic thought gave birth to the main
types of economic practices that are pursued by the modern economies.

• A market is a shorthand expression for the process by which households’

decisions about consumption of alternative goods, firm’s decisions about
what and how to produce, and workers’ decisions about how much and for
whom to work are all reconciled by adjustment of prices.

• These economies operate in what are referred to as markets, or market

economies.
 Types of market economies
The Command Economy: Is a society where the government makes all
decisions about production and consumption. A government planning office
decides what will be produced, how it will be produced, and for whom it will
be produced. Detailed instructions are then issued to households, firms
and workers.
The Invisible Hand: Markets in which Governments do not intervene are
called free markets. Individuals in a free market pursue their own interests,
trying to do as well for themselves without any Government assistance or
interference.
The Mixed Economy: In a mixed economy, the Government and private
sector interact in solving the economic problems. The Government controls
a significant share of output through monetary and fiscal policies such as tax,
Government expenditure, money supply etc.
 What is economics
• The study of how society decides “What”, “how”, and “for who” to produce.
Or the study of the use of scarce resources which have alternative uses.

• By emphasizing the role of society, the definition places economics within the
social science, a science that explains human behavior.

• However, the subject matter of economics is that part of human behavior

which relates to the production, exchange and use of goods and services.
 SCOPE OF ECONOMICS
• Much of economics is devoted to the study of how markets and prices
enable society to solve the problems of what, how and for who to produce.
Thus in answering the three fundamental questions above, economics
explains how scarce resources are allocated between competing needs of
society.
• The “What” refers to the physical goods such as steel, cars, and
strawberries. Services include activities such as live theatre performances.
• The “How” refers to the most efficient possible way to produce these goods
because you want to minimize the cost of producing these goods while at
the same time maximizing the benefits or outputs.
• “For who” refers to the end consumer. E.g, it is more prudent to make or
produce education material in a University or college setting, fertilizer in a
rural setting, etc.
 The basic principles of economics

• The central economic problem for society is how to reconcile the conflict
between people’s unlimited desires for goods and services, and the scarcity
of resources (such as labor, machinery, and raw materials) with which these
goods and services can be produced.

• This is explained by the concepts of Production Possibility Frontier (PPP) and

the Opportunity cost
 PRODUCTION POSSIBILITY FRONTIER
• PPP shows, for each level of the output of one good, the maximum amount
of the other that can be produced.

• It shows the maximum combination of outputs that can be produced using

the available inputs/resources.
• The PPP is drawn with a graph that is concave to the origin. This is because
of the law of diminishing returns. Movement from A to B to C each involve
trading off one unit of food output for film output. More of one output
implies less of the other.
• Point H is attainable because resources can not allow, G is inefficient, By fully
utilizing the available resources, the economy could expand output and
produce right on the frontier. A, B,C, D & E, are the optimal or desirable
points of production for the economy.
 Opportunity cost
• The principle of PPP works from the consumer’s point of view in a similar
manner that society must make a choice between goods and/or services.

• The opportunity cost of a good is the quantity of other goods which must be
sacrificed in order to obtain another unit of other good.
 PRACTICE QUESTION
• Using the principle of opportunity cost, determine 3 optimal points that are
available to the consumer from graph number 2 that was given in class.
1) As an individual, which point(s) would you prefer and why?
2) Which two points would you never chose, and why?
3) Mr. Zuze has two options, either to take up a job offer giving him K15,000
per months, or take up a scholarship for further studies. The course will
take him two years to finish and enable him obtain a Masters degree.
What is the opportunity cost of taking up the job for Mr. Zuze? What is the
opportunity cost of going to school for Mr. Zuze?
Bring your answers in the next class.
 COMPARISONS BETWEEN MICRO & MACRO
ECONOMICS.
Microeconomics is the study of particular markets, and
segments of the economy. E.g, individual human
behavior, individual households.

• Looks at issues such as consumer behavior, individual

labor markets and theory of the firms.

• For example, we might study why individual households

prefer cars to bicycles and how producers decide
whether to produce cars or bicycles.
• This dynamic characteristic of the economy helps
understand the complete pattern of consumption,
production, and exchange in the economy at a point in
time and is called General Equilibrium Theory.
 MICRO CONT’
• The complication attached to this is what necessitates the
separation of microeconomics from macroeconomics.

• Thus microeconomics will offer a detailed treatment of one

aspect of economic behavior and ignore the interactions with
other aspects of the economy.
• E.g A microeconomic analysis of miners’ wage would only
focus on characteristics of miners and the ability of mine
owners to pay, but would neglect indirect effects such as the
effect it would trigger on other industries e,g car industry.

• When microeconomics analysis ignores such effects, its

called partial analysis.
 MACROECONOMICS

Macroeconomics on the other hand is the study of whole

economy. It simplifies the individual building blocks of the
analysis in order to ensure a manageable analysis of the
complete interaction of the economy.

• Macroeconomists typically do not worry about the

breakdown of consumer goods into cars, bicycles, cars,
televisions and calculators. They simply treat them as a
single bundle because they want to understand the
interactions between household purchases and the firm.

• Looks at aggregate variables such as aggregate demand,

national output.
 MACRO CONT’

To give an idea of the building blocks of macroeconomics, we shall

look at three concepts we often talk about in macroeconomics.

• DGP- Gross Domestic Product is the value of all goods and services
produced in the economy in a given period such as a year. Basically
measures the total output of goods and services in the economy.

• Aggregate Price levels- Is the measure of the average level of prices of

goods and services in the economy, relative to their prices at some
fixed date in the prices. When the price level is rising, we say that the
economy is experiencing inflation.

• The Unemployment rate – Is the percentage of the labor force without

job. By labor force we mean the people of working age who in
principle would like to work if a suitable job was available.
MICRO ECONOMICS MACROECONOMICS
• Supply and Demand in
• Monetary/Fiscal policy. E.g what
individual markets.
effects does interest rates have
on the economy? What is the
• Individual Consumer behavior.
effects of education on health?
How individuals make decisions
• Why do we have unemployment
about particular commodities.
and inflation
• The dynamics of economic
• Individual labor markets.
growth
• International Trade and
• Externalities arising from
Globalization
production and consumption.
• Reasons for differences in living
standards
• Economic growth between
countries
• Government borrowing
 SIMILARITIES

• Micro principles are used in macroeconomics. If for example

you study the impact of inflation you are likely to use same
economics principles such as changes in prices.
• Microeconomics affects macroeconomics and vice versa. If
we see a rise in oil price, this impacts on inflation. If
technology reduces costs, this enables faster economic
growth.
• Blurring distinction: If house prices rise this is a
microeconomic effect for housing markets.
• But housing markets is so influential that it could also be
considered a macroeconomic variable and will influence
monetary policy.
END OF LECTURE ONE.
QUESTIONS