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Question: Discuss money in the open economy
-Money is a medium of exchange. It allows people to obtain what they need to live. In an open
economy it is used as a mode of transaction.
-An open economy is a type of economy where not only domestic factor but also entities in other
countries engage in trade of products.
-In an open economy market forces are allowed to determine production levels.
-It involves free interaction of one economy with other economies in the world. There are exports,
imports and capital flows. Funds flow across borders due to exchange of goods and services.
-Money relates to an open economy in that it is required to facilitate the interactions among the
economies.
MAIN SOURCES OF MONEY IN AN OPEN ECONOMY
1. Bank deposits: central banks monitor the amount of money in the economy by measuring
monetary aggregates consisting of cash and bank deposits.
2. Credit creation: Banks create credit by advancing loans on the cash credit basic and also by
purchasing securities and paying for them with its own cheques.
-Central banks affect the quantity of money in circulation by buying or selling government securities
through the process known as Open Market Operations. This frees up bank assets therefore they now
have more cash to loan.
HOW OPEN MARKET OPERATIONS CAN BE USED TO CONTROL CREDIT IN THE
ECONOMY
-Open Market Operations are carried out by the central bank in association with the commercial banks
thus reducing the money supply in the economy and restricting banks to offer credit to individuals.
3. Government borrowing: the government can borrow internally and externally, since its in an open
economy, which provides a wide range of finances in an open economy.
THEORY OF MONEY IN AN OPEN ECONOMY
-An increase in the supply of money in the open economy leads to an increase in activities being
carried out in the economy while a decrease in the supply of money in the open economy leads to a
decrease in the activities being carried out in the economy.
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FUNCTIONS OF MONEY IN AN OPEN ECONOMY
1. Medium of exchange: there are activities in an open economy. These activities involve exchange
of commodities among other things. Money is used as a medium of exchange hence facilitating the
activities in the open economy.
2. Measure of value: As exchange occurs the commodities have value. Commodities traded need to
have the same level of value. Money is used to measure the value of the commodities accordingly
hence used to carry out transactions.
3. Store of value: money is used to store value of commodities in an open economy for future
transactions.
4. Unit of account: It accounts for values of commodities in an open economy. This helps to facilitate
transactions in an open economy.
5. A standard of deferred payments: money facilitates running of activities in an open economy on
credit basis i.e. payments to be done in future for activities already carried out.
6. Transfer of value: Money is used to transfer value of commodities from players in an economy e.g
from a buyer to a seller.
DEMAND FOR MONEY IN AN OPEN ECONOMY
-Demand for money is the total amount of money that the population of an economy wants to hold.
-Money is demanded in an open economy for various reasons which include:
1. Transactionary
-Money is demanded in an open economy to enable transactions among the players. Activities in an
open economy include exchange of commodities and services i.e. acquiring and rendering them in
order for these activities to take place. There must be a form of transaction. Among the functions of
money is as a medium of exchange hence facilitates the transactions taking place effectively and
conveniently. This attributes the need for money because it is needed to carry out the transactions
hence its demand.
2. Speculative
-This is where money is needed to take care of opportunities as they arise. Like in any other economy
there are opportunities arising in an open economy. These opportunities need money so as to be
undertaken. This attributes to the need for money in order to undertake the opportunities thus
attributing demand for money. For example, trade opportunities.
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3. Precautionary
-This is the need for money to be used incase of emergencies i.e. taking precaution. In an open
economy there are risks such as recession periods, inflation among others. Also there are external
factors that pose a risk to the stability of an open economy e.g. Natural international calamities. For
instance covid-19. There is a need to take precaution against the risks especially the unpredictable
ones. Money is needed to take care of the effects of the risks when they have occurred. This attributes
to the demand of money in the open economy. It ensures smooth running of the economy even with
unexpected and unpredictable situations.
SUPPLY OF MONEY IN AN OPEN ECONOMY
-Supply of money refers to the total sum of money available to a public and private in an open
economy at a point of time.
DETERMINANTS OF MONEY SUPPLIED IN AN OPEN ECONOMY
-Money supply in an open economy is determined by:
1. Market rate of interest:
-When market interest rates are low there is larger supply of money in the open economy and when
the interest rates are high there is smaller supply of money in the open economy. Thus interest rates
and money supply are inversely proportional. When interest rate are low the economy grows and
inflation increases and when the interest rates are high the economy grows slowly and inflation
decreases.
2. Bank rates
-High bank rates cause a decrease in the supply of money in open economies. Consequently low bank
rates cause an increase in the supply of money in open economies. This is because high bank rates
discourage borrowing which causes the supply of money in an economy to reduce. High bank rates
encourage borrowing which attributes to more borrowing by players in an open economy leading to
an increase in supply of money in an open economy.
3. Currency deposit ratios
-This shows the amount of currency that people hold as a proportion of aggregate demand deposits.
Increase in cash deposits ratios leads to a decrease in money supply. This is because free money in the
open economy is being deposited. A decrease in cash deposits leads to an increase in money supply
because free money in an open economy i.e. float continues running and flowing in the economy
rather than being deposited.
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4. Reserve ratios
This is the percentage of commercial bank deposits that banks must keep in cash as a reserve. An
increase in reserve ratios lead to a decrease in the supply of money in an open economy.
Consequently a decrease in reserve ratios attributes to an increase in supply of money in the economy.
FLOW OF MONEY IN AN OPEN ECONOMY
-It depicts the way money and credit circulates as income turns into savings and investments and back
again.
-It is important in a number of ways e.g. it links consumers and producers.
- Money flows in the economy in three ways:
1. Production
2. Consumption
3. Exchange
-Consumption and production flows operates simultaneously and are interrelated and interdependent.
-Generally money flows in an open economy through transactions made i.e. payments made and
payments received.
-Money that flow in an economy is usually facilitated by the players in the economy i.e. the different
economies involved and it can be regulated also by the economies involved.

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Question: Discuss money in the open economy -Money is a medium of exchange. It allows people to obtain what they need to live. In an open economy it is used as a mode of transaction. -An open economy is a type of economy where not only domestic factor but also entities in other countries engage in trade of products. -In an open economy market forces are allowed to determine production levels. -It involves free interaction of one economy with other economies in the world. There are exports, imports and capital flows. Funds flow across borders due to exchange of goods and services. -Money relates to an open economy in that it is required to facilitate the interactions among the economies. MAIN SOURCES OF MONEY IN AN OPEN ECONOMY 1. Bank deposits: central banks monitor the amount of money in the economy by measuring monetary aggregates consisting of cash and bank deposits. 2. Credit creation: Banks create credit by advancing loans on the cash credit basic and also by purchasing securities and paying for them with its own cheques. -Central banks affect the quantity of money in circulation by buying or selling government securities through the process known as Open Market Operations. This frees up bank assets therefore they now have more cash to loan. HOW OPEN MARKET OPERATIONS CAN BE USED TO CONTROL CREDIT IN THE ECONOMY -Open Market Operations are carried out by the central bank in association with the commercial banks thus reducing the money supply in the economy and restricting banks to offer credit to individuals. 3. Government borrowing: the government can borrow internally and externally, since its in an open economy, which provides a wide range of finances in an open economy. THEORY OF MONEY IN AN OPEN ECONOMY -An increase in the supply of money in the open economy leads to an increase in activities being carried out in the economy while a decrease in the supply of money in the open economy leads to a decrease in the activities being carried out in the economy. FUNCTIONS OF MONEY IN AN OPEN ECONOMY 1. Medium of exchange: there are activities in an open economy. These activities involve exchange of commodities among other things. Money is used as a medium of exchange hence facilitating the activities in the open economy. 2. Measure of value: As exchange occurs the commodities have value. Commodities traded need to have the same level of value. Money is used to measure the value of the commodities accordingly hence used to carry out transactions. 3. Store of value: money is used to store value of commodities in an open economy for future transactions. 4. Unit of account: It accounts for values of commodities in an open economy. This helps to facilitate transactions in an open economy. 5. A standard of deferred payments: money facilitates running of activities in an open economy on credit basis i.e. payments to be done in future for activities already carried out. 6. Transfer of value: Money is used to transfer value of commodities from players in an economy e.g from a buyer to a seller. DEMAND FOR MONEY IN AN OPEN ECONOMY -Demand for money is the total amount of money that the population of an economy wants to hold. -Money is demanded in an open economy for various reasons which include: 1. Transactionary -Money is demanded in an open economy to enable transactions among the players. Activities in an open economy include exchange of commodities and services i.e. acquiring and rendering them in order for these activities to take place. There must be a form of transaction. Among the functions of money is as a medium of exchange hence facilitates the transactions taking place effectively and conveniently. This attributes the need for money because it is needed to carry out the transactions hence its demand. 2. Speculative -This is where money is needed to take care of opportunities as they arise. Like in any other economy there are opportunities arising in an open economy. These opportunities need money so as to be undertaken. This attributes to the need for money in order to undertake the opportunities thus attributing demand for money. For example, trade opportunities. 3. Precautionary -This is the need for money to be used incase of emergencies i.e. taking precaution. In an open economy there are risks such as recession periods, inflation among others. Also there are external factors that pose a risk to the stability of an open economy e.g. Natural international calamities. For instance covid-19. There is a need to take precaution against the risks especially the unpredictable ones. Money is needed to take care of the effects of the risks when they have occurred. This attributes to the demand of money in the open economy. It ensures smooth running of the economy even with unexpected and unpredictable situations. SUPPLY OF MONEY IN AN OPEN ECONOMY -Supply of money refers to the total sum of money available to a public and private in an open economy at a point of time. DETERMINANTS OF MONEY SUPPLIED IN AN OPEN ECONOMY -Money supply in an open economy is determined by: 1. Market rate of interest: -When market interest rates are low there is larger supply of money in the open economy and when the interest rates are high there is smaller supply of money in the open economy. Thus interest rates and money supply are inversely proportional. When interest rate are low the economy grows and inflation increases and when the interest rates are high the economy grows slowly and inflation decreases. 2. Bank rates -High bank rates cause a decrease in the supply of money in open economies. Consequently low bank rates cause an increase in the supply of money in open economies. This is because high bank rates discourage borrowing which causes the supply of money in an economy to reduce. High bank rates encourage borrowing which attributes to more borrowing by players in an open economy leading to an increase in supply of money in an open economy. 3. Currency deposit ratios -This shows the amount of currency that people hold as a proportion of aggregate demand deposits. Increase in cash deposits ratios leads to a decrease in money supply. This is because free money in the open economy is being deposited. A decrease in cash deposits leads to an increase in money supply because free money in an open economy i.e. float continues running and flowing in the economy rather than being deposited. 4. Reserve ratios This is the percentage of commercial bank deposits that banks must keep in cash as a reserve. An increase in reserve ratios lead to a decrease in the supply of money in an open economy. Consequently a decrease in reserve ratios attributes to an increase in supply of money in the economy. FLOW OF MONEY IN AN OPEN ECONOMY -It depicts the way money and credit circulates as income turns into savings and investments and back again. -It is important in a number of ways e.g. it links consumers and producers. - Money flows in the economy in three ways: 1. Production 2. Consumption 3. Exchange -Consumption and production flows operates simultaneously and are interrelated and interdependent. -Generally money flows in an open economy through transactions made i.e. payments made and payments received. -Money that flow in an economy is usually facilitated by the players in the economy i.e. the different economies involved and it can be regulated also by the economies involved. Name: Description: ...
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