INTRODUCTION: TRADE AND MONEY economy barter

Economics/ Money Name ________________________________ Date _________________________

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INTRODUCTION: TRADE AND MONEY Trading is a basic human behavior. The study of trade and trade behaviors is called economics. The trade activities of a specific group of people may be called an economy. The practice of trading and negotiating prices is so common that many people are not even aware that they are surrounded by trade all the time. One common form of trade and negotiation that many people engage in without realizing it is barter. Barter is the direct exchange of goods and services. One example of barter is trading collectible items (such as baseball cards). Many people also engage in informal bartering, such as trading chores with members of a household ("I'll do the dishes if you do the laundry") or simple trades like the ones common in school cafeterias-- trading one kind of sandwich for another. For much of human history, most trading was carried out through barter. However, most modern economies are not barter economies. In modern economies, most people work for an employer in exchange for a wage, which is paid in money. They then trade that money for goods and services. The fact that most people use money to get goods and services leads them to believe that the money itself has inherent value. In reality, nothing could be further from the truth. However, the widespread confusion about the value of money does raise the question: What is money? Money is everywhere around us, yet few people ever stop to wonder what it is, where it comes from, or why it's considered valuable. Economists believe that, at its most basic level, money is anything that can serve as a medium of exchange, a unit of account, and a store of value. Many things may serve one or two of these functions but in order to be considered to be money, all three of these elementary functions must be served. The following is a story of money that will illustrate these functions as well as other aspects of money and how it works.



A Story of Money Part One: The Beginning of Money Once there was an isolated village. In this village lived a butcher named Ellen, a baker named José, a candlestick maker named Ian and a yoga instructor named Rachel. Ellen the butcher wanted to take yoga lessons from Rachel. She offered to trade a chicken to Rachel in exchange for a one-hour yoga lesson, but Rachel was a vegetarian and had no use for chickens. Rachel did like bread, however, and she had trouble getting enough because José, the baker, was not interested in taking yoga lessons. So Ellen went to José the baker and offered to trade a chicken to him in exchange for two loaves of fresh bread. José accepted the chicken, and Ellen took the bread to Rachel and exchanged it for a one-hour yoga lesson.

Ellen, José and Rachel used this arrangement for a long time. After a while, Ellen got tired of carrying a chicken to José's bakery and then taking two loaves of bread to Rachel's yoga studio. Also, it sometimes happened that José wasn't in the mood for chicken when Ellen stopped by to trade for bread, or that Rachel didn't need bread when Ellen stopped by to trade for yoga lessons. The system usually worked but it was awkward for everyone. Then, one day, Ellen had an idea: she owned a box full of medals that her grandfather had won a long time ago, when he used to race against people from other villages. The medals were unique and would be difficult to copy, but they had no other practical value. So she spoke with José and Rachel and they came up with a new arrangement. When Ellen went in for a yoga lesson she would bring one of her grandfather's medals to trade to Rachel. Rachel could then trade the medal to José for bread when she was in the mood for bread, and José could bring the medal back to Ellen and trade it for a chicken when he was in the mood for chicken. This way José and Rachel could have chicken and bread when they were in the mood for it and Ellen didn't have to carry chickens and bread all over the place. This was a good arrangement and it worked for everyone.



Part One: The Beginning of Money, continued It later happened that Rachel realized she needed some candlesticks to light her yoga studio so she went to Ian the candlestick maker and asked if he would like to trade a one-hour yoga lesson for ten candles. Ian said he wasn't interested in yoga-- but he was running low on the animal fat he used to make candles. This gave Rachel an idea. She went away and came back with one of Ellen's medals. She explained to Ian that he could take the medal back to Ellen's butcher shop and that the medal was worth one chicken to Ellen. Ian could make some kind of arrangement with Ellen to buy "one chicken's worth" of animal fat from her in exchange for the medal. Ian thought this was a fine idea and he accepted the medal from Rachel in exchange for ten candles. When Ian brought the medal back to Ellen, she was surprised to find that the system she worked out with José and Rachel had been expanded to include Ian. Ellen arranged to sell Ian twenty pounds of animal fat in exchange for the return of the medal. She also asked Ian if she could bring him medals in the future to trade for candlesticks. He could always return the medals to her in exchange for twenty pounds of animal fat whenever he was running low-- or for a chicken if he was in the mood for chicken. Ian liked this idea and agreed to Ellen's terms. When José heard about the arrangement that Ellen, Rachel, and Ian had worked out, he asked Ellen if he could also trade the medals to other people. Ellen said this would be fine, so José approached the farmer he bought wheat from and offered him some of Ellen's medals in exchange for wheat. The farmer accepted and then used some of Ellen's medals to buy new tools from the blacksmith who traded some of the medals to Ian in exchange for candlesticks. Soon the whole village was using Ellen's medals as tokens for trade. People could still trade one thing for another-- they could still trade a chicken for two loaves of bread --but they usually found the medals more convenient because they could be saved until the buyer wanted something in particular, like a chicken or a loaf of bread. They were also easier to carry around than trade goods.



DISCUSSION

Part One of "A Story of Money" illustrates some basic characteristics of money, where it comes from, and how it works. One of the basic characteristics of money, as shown in the story, is its elementary function as a medium of exchange.

• A medium of exchange is any token that is commonly accepted as payment for a debt. The term describes the role of the token. The token need not have any inherent value; it is only a symbol of something else being traded.

Consider the example of Ellen's arrangement with José and Rachel. Ellen's medal essentially means that she owes the bearer one chicken; that debt can then be carried from Rachel to José and back to Ellen. The economics of their arrangement do not change when they begin using Ellen's medals. Ellen still "spends" one chicken and "buys" one yoga lesson; likewise, Rachel spends a yoga lesson and buys two loaves of bread while José spends two loaves of bread and buys one chicken. Before they begin using medals, Ellen and her friends engaged in a direct exchange of goods and services (barter). Afterward, they continue to exchange goods and services, but medals serve as the medium of that exchange.

Another way to think of this is that if you walk up to someone and say, "Hello," you are telling them "Hello" directly. If you write "Hello" on a note and hand it to someone, the note is the medium through which you are saying "Hello" to them. That's all a medium of exchange is: the medium through which an exchange takes place.

A second basic concept that appears in Part One of "A Story of Money" is the concept of supply and demand. Supply and demand refers to a theory in economics which basically states that the value of any trade good or service is determined by how much of it there is (supply), and how badly people want it (demand). So, for example, sand has an extremely low trade value because it's easy to get (large supply) and doesn't have many uses (small demand). On the other hand, computers have a high trade value because they're difficult to make (small supply) and have many uses (large demand).

In the case of Ellen and her friends, Ellen was sometimes unable to trade her chickens because her friends did not have an immediate demand for them. She may have been able to overcome this problem by lowering her price. Even if José was not in the mood for chicken, he may have been willing to take one in trade if Ellen offered to trade him one chicken for one loaf of bread. However, it is unlikely that Ellen would make such an offer



because she has a limited supply of chickens and must use that supply to meet her basic trading needs.

A medium of exchange makes trade more efficient because it changes the question a buyer must ask from, "Do I want a chicken right now?" to, "Will I want a chicken at some point in the future?" It expands demand from an immediate demand to a general demand. Consider the situation in the story: before medals, Ellen couldn't get her yoga lesson from Rachel unless José needed a chicken and Rachel needed bread. If either of Ellen's trading partners didn't need her product when Ellen came to trade, Ellen had to wait to get her yoga lesson because there was no immediate demand for her goods. The use of medals fixed that problem, allowing Ellen and her friends to exchange goods and services on their own timetables, rather than having to coordinate their buying and spending habits.

Many people mistakenly believe that money originated to meet this basic need-- the need to simplify trade. However, most historians agree that the earliest examples of money, like Ellen's grandfather's medals, were tokens of admiration or esteem. It's no accident that many of the medals awarded to athletes and soldiers look like coins (or vice versa). Long before people invented money, they exchanged rare or beautiful objects as signs of friendship or respect. Different cultures used different tokens-- shells, beads, coins, jewels, medals or weapons were common --but many cultures preferred objects made out of precious metals like gold and silver for such tokens because of their innate beauty. Some early forms of money were also used as ritual offerings for religious ceremonies.

In other words, money, like trade itself, began as a tool for social interaction. Most early forms of money derived their value from the social implications of having or giving it-- rather than any innate value due to rarity or utility. This point doesn't mean much when you're trying to figure out how much a candy bar costs, but it is useful when considering modern attitudes towards money and its value to keep in mind that money began as something that was given away as a sign of respect and friendship.



COMPREHENSION QUESTIONS, PART ONE VOCABULARY QUESTIONS

• economics • medium of exchange • barter • supply and demand Write the word or phrase from the list above next to the correct definition 1. _______________________ The study of trade and trade behaviors 2. _______________________ Any token that is commonly accepted as payment for a

debt 3. _______________________ The direct exchange of goods and services 4. _______________________ A theory in economics which basically states that the

value of any trade good or service is determined by how much of it there is, and how badly people want it

MULTIPLE CHOICE QUESTIONS 1. Why couldn't Ellen just trade chickens to Rachel in exchange for yoga lessons?

a. Because chickens had no value for Rachel. b. Ellen didn't have enough chickens to trade to Rachel. c. Rachel already had enough chickens. d. Rachel didn't have any yoga lessons available.

2. Why was Ellen able to trade bread to Rachel for yoga lessons?

a. José never traded bread to Rachel. b. Rachel wanted more bread than she was usually able to get. c. Rachel didn't want any chickens. d. José was not interested in chicken.

3. Ellen might have used chicken bones or rocks for trade tokens, instead of using

her grandfather's medals; why did she use medals instead? a. Chicken bones and rocks are easy to come by. b. Chicken bones and rocks have practical uses. c. José and Rachel would be unlikely to accept chicken bones or rocks as

trade tokens. d. Chicken bones and rocks are not particularly easy to carry.

4. Why did Ian agree to take one of Ellen's medals from Rachel in trade for

candlesticks? a. Ian was more interested in yoga lessons. b. Ian wanted a chicken. c. Ian needed something Ellen had, and he believed he would be able to

use the medal to get it. d. Ian was a vegetarian and could not eat the chicken.



A Story of Money

Part Two: Effects of Money in an Economy

Ellen soon found that the demand for her chickens went up because the medals made it possible for people she hadn't previously traded with to get credit at her butcher shop. For example, Ellen never used to trade directly with Donald the wine merchant because Ellen didn't like wine. But Donald traded wine to someone else for some of Ellen's medals and now he could trade the medals to Ellen for her chickens. Other merchants found a similar thing happening: they were able to trade with many new people because the medals simplified trade between people who might not have had anything to offer one another before. One day, José needed a chicken for a special dinner-- but he didn't have any of Ellen's medals. He brought her two loaves of bread instead but Ellen didn't need any bread that day. However, she liked José so she offered him a special arrangement: she'd give him a chicken now if he brought her a medal later. Medals were so commonly exchanged that Ellen knew José would get some in the future. José agreed to this and wrote Ellen an IOU ("I owe you") for one medal or two pieces of bread on a piece of paper. That way if Ellen wanted bread before José brought her a medal she could just bring the IOU by his bakery and redeem it for bread. Soon people all over the village noticed that they were running short of medals and that many people were trading IOUs. Many merchants began offering different rates of trade for different kinds of payment: people who could pay in medals got the best price. People who bought things with trade goods were charged a slightly higher price because trade goods were not as convenient as medals. People who paid for goods with IOUs paid the highest price of all. This was because merchants were worried that some people might not make good on their IOUs. They charged more in order to make up for the losses they would suffer if some people didn't pay them


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back. In any event it soon became clear to the villagers that their supply of medals wasn't large enough to meet their needs. Part Two: Effects of Money in an Economy, continued Once the villagers realized they were running short of medals they all got together to decide what they should do; people liked using the medals for trade but there weren't enough of them to go around. The IOU system had been working well enough, but IOUs were easy to copy and people had been having trouble keeping track of them. The villagers decided to have the blacksmith make new medals to add to the medals that were already in use. In order to figure out how many medals they might need they counted all the medals that were in use, then added the number of IOUs that people had written. This gave the villagers an idea what the demand for medals was.

+ A problem came up when the villagers compared the demand for medals to Ellen's supply of chickens and found that Ellen did not have enough chickens on hand to satisfy the demand if everyone should choose to trade in their medals at once. At first the villagers weren't sure what to do about this; if Ellen didn't have enough chickens to redeem the medals, how would the village establish the value of medals compared to other trade goods? Then the villagers decided that this wasn't a problem after all because people didnʼt only use Ellen's medals for chickens. When Ellen traded a medal away it could be weeks or months before the medal would make its way back to her. In the meantime, the medal was traded around the village as a token for dozens of other goods. Although Ellen had hundreds of medals in circulation around the village, she rarely traded more than a few chickens a day-- and when she got medals back she tended to just turn around and spend them again. When the villagers realized that Ellen's medals were only rarely redeemed for chickens, they decided to try an experiment. Everyone gave the blacksmith the IOUs they had collected. The blacksmith gave the merchants medals in exchange for the IOUs. This meant that the new medals had the same value to the merchants as the IOUs they had given to the blacksmith. The merchants who had taken new medals in trade for their IOUs insisted on trading the medals at the same value as the IOUs-- because they had paid an IOU to get the medal. When Ellen traded José's IOU to the blacksmith for a new medal, she then traded that medal to Ian at the same value as two loaves of bread. If she had accepted less than the value of two loaves of bread in trade for the new medal, she would have been cheating herself. Ian then traded the medal that Ellen had given her at the value of two loaves of bread-- because if he were to accept less than the value of two loaves of bread for the medal, he would have been cheating himself.


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After a while all medals were trading at the same rate throughout the village even though none of them could necessarily be redeemed for chickens. The villagers met once a year to discuss the supply of medals, making sure there were neither too many nor too few in circulation. They also introduced smaller medals of lesser value, such as half-medals, quarter-medals and one-eighth-sized medals. As time passed the practice of using medals as tokens of trade became so common that the villagers grew cautious about direct trades. If Ellen offered to trade two chickens to Hassan the cobbler for a pair of shoes, Hassan couldn't be sure what the chickens were worth because he didn't necessarily know what the market value of chickens was compared to shirts or candles or other items he might want. However, if Ellen offered to trade Hassan two medals, Hassan had a good idea what he could buy with those medals because he knew the price, in medals, of most trade goods-- so the trade was easier. As the practice of trading in medals became more common than other methods of trade, medals became the common measurement of value for all goods and services, as well as a measure of debt, wealth, and income. If Ellen let José take a chicken without paying for it, she didn't record the debt as, "José owes Ellen one chicken," even, "José owes Ellen two loaves of bread;" she simply said that José owed her one medal, because that was the price of the chicken. ************************************************************************************************

Draw a picture to show how trade happened in the village before the medals.

Draw a picture to illustrate a trade after the medals became a kind of money.


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DISCUSSION

Part Two of "A Story of Money" shows some different kinds of money and some problems that may arise from the use of money. It also illustrates another elementary function of money; money serves as a unit of account.

• A unit of account is a monetary denomination in which accounts of any sort may be kept; that's a long way of saying that when people do business with money, they naturally tend to figure their accounting in medals or dollars or whatever they're using for money. Monetary denomination just means "kind of money." In a system without money, a person might measure their income in many different units: when Ellen added up all her income for a month before her village started using medals she might have said she took in 10 loaves of bread, 60 candlesticks, 5 hours of yoga lessons and so on. After she started trading in medals it was easier for her to simply keep track of her business in terms of how many medals she spent and how many she took in. Units of account are a natural consequence of using money as a medium of exchange.

In addition to this basic characteristic of money, Part Two of "A Story of Money" also shows us a simplified version of some very complicated facts about money and how it has changed over time.

Like the people of Ellen's village, most cultures that use money started out using commodity currencies. Commodities are trade goods. Currencies are types of money. Commodity currencies are currencies that derive their value from a specific commodity-- like Ellen's chickens. These currencies are handy because it's easy for people to believe in their value; the idea that one medal is worth one chicken is pretty easy for most people to understand, whether they like chicken or not.

The main problem with commodity currencies is that they are prone to deflation. Basically, deflation is when there isn't enough money in circulation to meet the needs of the economy, like when the people of Ellen's village found that they didn't have enough medals to use them for all their purchases and were forced to start trading IOUs. The shortage of money causes the value of money relative to goods and services to go up, as it did in Ellen's village when the villagers started offering better prices for goods if the buyer could pay in medals. In other words, deflation causes prices to go down because the supply of money in circulation has shrunk or "deflated," thus increasing the demand for money. While the term deflation was coined to refer to a


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reduction in the money supply, modern economists use the term to describe any general decrease in prices-- so not all deflation is necessarily about a shortage of money.

The problem with deflation is that it "slows down" the economy. The use of medals allowed the people of Ellen's village to trade more among themselves; Steve bought more chickens from Ellen because medals gave him a trade item that Ellen had a demand for. Likewise Ellen was able to take yoga lessons from Rachel more often because medals made it easier for her to convert her chickens into something Rachel wanted. When the supply of medals in the village became deflated it became harder for people to buy things. Everyone still had things to trade, but the loss of the efficiency generated by medals made the trades harder to arrange, so everyone had less of what they wanted. Ellen's village responded to this problem by getting rid of their commodity currency and replacing it with a fiat currency.

Fiat currencies, also known as fiduciary currencies or fiduciary issue, are currencies issued by a government, the value of which are set by government decree (fiat is a very old word that basically means "because I said so.") Fiat currencies are not backed by any commodity and cannot be redeemed for anything by the government that issues them. Their value is decided by a combination of government fiat and social traditions. In the case of Ellen's village, the value of the new medals was established by common agreement within the community. This works because the village is a small community with a great deal of trust and good will among its members. In larger economies, it is common for governments that issue fiat currencies to demand that taxes be paid only in their currency. This guarantees that the currency will always have value in the marketplace, particularly if the government demands a tax on the value of homes or an income tax, so that people must pay taxes in the fiat currency in order to maintain ownership of their personal property.


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COMPREHENSION QUESTIONS, PART TWO VOCABULARY QUESTIONS

• fiat currencies • monetary denomination • deflation • unit of account • commodity currencies Write the word from the list above next to the correct definition

1. _______________________ Currencies issued by a government, the value of which are set by government decree

2. _______________________ A monetary denomination in which accounts of any sort may be kept

3. _______________________ A specific kind of money 4. _______________________ Currencies that derive their value from a specific

commodity 5. _______________________ An economic slowdown, often caused by a shortage

of currency MULTIPLE CHOICE QUESTIONS 1. Why was Ellen able to sell more chickens after the village started using medals?

a. More people heard about her and came to her for chickens. b. People were grateful to her for inventing the medals system. c. Medals increased the efficiency of trade, thus increasing the demand for

all kinds of trade, including chickens. d. The commodity backing the medals was chickens, so people frequently

traded the medals in for chickens. 2. Why did the village run short of medals?

a. Medals were so popular that there were more transactions taking place than the supply of medals could satisfy.

b. Ellen did not have enough chickens to meet the village's demand for medals, so she could not put more medals into circulation.

c. Some villagers were hoarding medals. d. People occasionally lost medals and, over time, the losses were enough to

upset the system. 3. Why did the village switch over to a fiat currency?

a. The supply of a fiat currency could be increased to meet the needs of the community.

b. Ellen did not want to breed more chickens to meet the village's need for medals.

c. Some people who used medals did not want chickens, so the medals were worthless to them anyway.

d. None of the above.


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A Story of Money

Part Three: Money as Wealth

Over many years, the practice of using medals to measure the value of goods and services led people to believe that having a lot of medals was the same thing as having a lot of goods and being able to hire a lot of services. To some extent they were right.

For example, before the use of medals, if Ellen wanted to buy 100 loaves of bread all at once she would have to arrange with José for him to take 50 of her chickens. She would then have to set aside a few of her chickens every week, until she had 50 extra chickens to trade to José. This would mean having fewer chickens to trade for yoga lessons and candles while she was saving for the bread. It would also mean she would have to feed and keep track of all the extra chickens until she could make the trade. After the village started using medals, Ellen could set aside a portion of her income as medals until she had enough medals to make her purchase. She would still have to go without yoga lessons and candles in order to save, but the new method was much more convenient than the old way because she did not have to feed or protect 50 extra chickens. She could simply set aside the value of the chickens a bit at a time until she had enough medals to equal the value of 50 chickens.

However, over a very long time people began to lose track of the fact that medals only served as tokens of value. They began to think that the medals had a value of their own and this led them to do a very strange thing.

One day Ellen decided she wanted to take more yoga lessons. Before the village used medals, Ellen would have had to either set aside some of her chickens, giving up other things in order to afford the yoga lessons, or she would have had to use some of her chickens to buy things that would allow her to breed more chickens: coops, fencing, feed, and straw for nests. Spending some of her chickens on these new supplies would increase the number of chickens she could breed every week so that she could afford extra yoga lessons without having to give up bread or candles, but it would also increase the amount of work she would have to do in order to breed the extra chickens.

After the village starting using medals, Ellen still had the same two choices with regard to extra yoga lessons: give up some things in order to afford the lessons, or invest and increase the number of chickens she could breed every week. But there was also a third new possibility: rather than increasing the number of chickens she was breeding, she could just increase the price of her chickens.

Of course, she could also have increased the price of her chickens before medals. She could always ask José for three loaves of bread in trade for one chicken. But that would be a very large increase. José would have noticed it and he might have decided to buy fewer chickens, so Ellen wouldn't really gain anything. However, with medals Ellen could increase the price of her chickens by a tiny amount: rather than


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charging one medal per chicken, she could try charging one and one-eighth medals for her chickens.

Part Three: Money as Wealth, continued

Ellen tried a slight price increase and found that it was small enough not to put people off buying her chickens. She still sold about the same number of chickens every week, and now she had a little bit of extra income to spend on yoga lessons.

This system worked fine for Ellen. One day she mentioned her plan to José. He thought that was a pretty good idea so he increased the price of his bread a tiny amount. Ian noticed what Ellen and José were doing, and he increased the price of his candlesticks a tiny amount. Then Rachel increased the price of her yoga lessons. Pretty soon other villagers noticed that they were spending more medals on bread, chicken, candles and yoga lessons. They had to budget more carefully and they didn't have as many medals left over for their own savings as they had before. So the other villagers began to increase the prices of their goods and services in order to make up for the increase in the prices of Ellenʼs, Joséʼs, Ianʼs and Rachel's goods and services. Soon the prices of pretty much everything in the village had gone up by one-eighth.

The sudden price increase resulted in a shortage of medals. The villagers gathered together to discuss this situation and decide how it should be handled. Many villagers were worried that if the blacksmith created more medals to fix the shortage then people would just increase their prices again: soon it would cost 100 medals to buy a chicken. Not only would that be a ridiculous amount, it would also mean that people who had been saving their income by saving medals would find that their savings were suddenly worthless. This idea made many villagers very nervous.

Some people suggested avoiding that problem by creating price controls, limiting the amount that villagers could charge for certain goods. But many of the villagers didn't like that idea, because some goods, such as fruit, were worth more or less depending on how long they had been sitting around, or how good the harvest was on a given year. Other villagers suggested just ignoring the problem; the shortage of medals would force everyone to reduce their prices sooner or later. People objected to that plan because the shortage of medals made it harder to trade and hurt everyone's business.

The villagers discussed many other ideas for handling the new problem. At the end of a long time of talking it over, they decided that the best thing would be to allow everyone to set their own prices. In the long run this would probably mean that there would be a very slight but constant increase in prices over time. The villagers decided that if the increase in prices became too drastic-- more than one-eighth per year --they would meet and create short-term price controls to keep things from getting out of hand. Otherwise, the blacksmith would do periodic surveys of the prices of things in the village and make more medals in order to maintain a relatively constant supply.


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This system worked reasonably well. Sometimes the villagers had to make up new rules or get rid of old ones, but the village continued to use medals for many years. Soon other villages noticed the success of the merchants in the isolated village and begin to create similar systems of their own.


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DISCUSSION Part Three of "A Story of Money" illustrates the third and final elementary function of money, which is its usefulness as a store of value. • A store of value is a medium of exchange that maintains its value over

time. This use of money can be observed in Ellen's preparations to save up for a major bread purchase from José. Each medal she saves maintains its value until she is able to amass enough medals to make her purchase. Ellen could have done the same thing by setting aside some chickens, but that method would require Ellen to feed and care for the chickens in order to keep them healthy. This meant that Ellen had to spend additional money on chicken feed to maintain her "savings" of chickens, or they would become sick and lose value over time. In this respect, medals were more convenient than chickens. Part Three also illustrates a danger of using money as a store of value: money sometimes loses value over time. This is called inflation. Strictly speaking, inflation is when there is too much money in circulation-- which is to say that the supply of money has "inflated" --but the term may also be applied to any general increase in prices without an overall increase in demand. Inflation is comparatively uncommon in commodity currencies because their value is attached to the value of trade goods, and trade goods generally maintain their value relative to each other. This is to say that if one chicken is worth two loaves of bread when you're 10 years old, chicken and bread will probably still be trading at about that rate when you're 50. If one medal is worth one chicken, and the value of chicken stays constant, so does the value of your medal. The stability of commodity currencies in this regard is one reason that many countries with fiat currencies have groups of people who advocate a return to commodity currencies. Fiat currencies are different because their value isn't anchored to any one trade good. One chicken can be worth two loaves of bread, but if the value of medals isn't anchored to one of those items then it doesn't matter if one chicken is worth one medal or one hundred medals-- as long as the two loaves of bread sell for the same price as the chicken. In modern economies, there are many causes of both inflation and deflation. Most of these causes are much more complicated than the ones described in "A Story of Money." It is useful to keep in mind that all trade, no matter how complicated it may be by money, credit, exchange rates or other complex variables, is basically as simple as Ellen trading one chicken to José for two loaves of bread.


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COMPREHENSION QUESTIONS, PART THREE MULTIPLE CHOICE QUESTIONS 1. Why did Ellen increase the price of her chickens?

a. The chickens were costing her more to produce and she needed to recover the extra cost.

b. Her chickens had not been breeding well, so she had fewer chickens on hand.

c. She felt she deserved to be able to take yoga lessons without saving or working harder.

d. She wanted to increase her income without increasing her output. 2. When Ellen increased the price of her chickens, who paid the difference?

a. Nobody. b. Rachel. c. Ellen's customers. d. The entire village.

3. Which of the following would cause inflation in a commodity currency?

a. Something reduces the supply of the commodity that backs the currency, such as if Ellen's chickens got sick and many of them died.

b. It becomes much easier to produce the commodity backing the currency, such as if Ellen invented a machine that allowed her to breed 100 times as many chickens.

c. The demand for the commodity backing the currency drops off and does not recover, such as if everyone decided that chicken was bad for them and stopped eating Ellen's chickens.

d. None of the above. 4. Which of the following scenarios would cause deflation in a fiat currency?

a. The government that issued the currency is overthrown or collapses. b. It becomes much easier to produce most goods in an economy, such as

if a machine was invented that could bake bread, breed chickens, make candles and teach yoga-- all with much less effort than had previously been required.

c. The government refuses to issue any more currency and forces people to make due with the existing supply.

d. B and C above. ESSAY QUESTION Now that you know some basic facts about money, would it be possible for you to create your own money? If not, why not? If so, what would you need to do in order to make your money fill the three elementary functions? Please explain your answer.


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Answer Key: PART ONE Vocabulary questions: 1. economics 2. medium of exchange 3. barter 4. supply and demand Multiple choice questions: 1. a 2. b 3. a 4. c PART TWO Vocabulary questions: 1. fiat currencies 2. unit of account 3. monetary denomination 4. commodity currencies 5. deflation Multiple choice questions: 1. c 2. a 3. a PART THREE Multiple choice questions: 1. d 2. c 3. b 4. d Essay question: Answers may be yes or no, depending on how hypothetical the student is inclined to be in their response, but in either case should address each of the three functions of money: medium of exchange, unit of account, and store of value.

INTRODUCTION: TRADE AND MONEY economy barter

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