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We began this chapter with a deceptively simple question about money: why do people want it? To answer that question, we first looked at what money is. We discovered that money is an asset that has certain defining characteristics, such as portability, divisibility, and durability. Most importantly of all, though, we said that money must have acceptability. What turns an asset into a money, ultimately, is the simple fact that enough people are willing to treat it as such.
If we look through history, we find that many different things have served as money in different places and at different times. As well as the familiar notes and coins, these include seashells, stones, cigarettes, cans of food, gold, and silver. These could successfully function as money because they were acceptable as money in their particular context.
We then imagined that you were lucky enough to find a $100 bill on the sidewalk and explored the various things that you could do with this money, including buying goods and services, buying other currencies, and buying assets. As we did so, we explored a number of different arguments, all based on arbitrage, that help us to understand the relationships between interest rates, exchange rates, asset prices, and inflation rates. We argued that arbitrageurs will step in when there are easy profit opportunities. Arbitrage does not say that riskless profit opportunities cannot exist. It says that they will not persist. If a riskless profit opportunity were to exist, then people would very quickly take advantage of it and, by so doing, eliminate it.
Expressed more metaphorically, economists often say that there are no $100 bills lying on the ground waiting to be picked up. It is not that it is impossible for someone to drop a $100 bill, but if one person has dropped a large bill, someone else will almost certainly pick it up very quickly. There is an immediate and powerful lesson of arbitrage, one that you should bear in mind throughout life. If someone tells you of a surefire way to make easy money, beware!
(Advanced) Using the relationshipprice of euro in dollars × price of dollar in euros = 1,
how would you draw the supply and demand curves and depict equilibrium in the market for dollars and the market for euros?