AP Macroeconomics Unit 4 Essentials

A dollar bill has no real intrinsic value — it's a piece of paper. Money functions as a medium of exchange, store of value, and unit of account only because people collectively agree to accept it and trust it will retain value. That's why hyperinflation is so destructive: once people stop trusting a currency to hold its value, it stops functioning as money at all, no matter what's printed on it.

Only the central bank can print currency, but commercial banks create the vast majority of the money supply simply by making loans. When a bank lends out its excess reserves, that borrowed money gets deposited elsewhere, which becomes new excess reserves for another bank to lend — and the cycle repeats. This is why the money multiplier can turn a single new deposit into a much larger total expansion of the money supply.

The Federal Reserve doesn't directly set how much businesses invest or how much households spend — it changes the money supply, which changes the interest rate, which then changes borrowing and spending decisions throughout the economy. This indirect chain (money supply → interest rate → investment/consumption → aggregate demand) is the entire logic of monetary policy, and tracing through each link correctly is the key skill this unit tests.