Definition
Gresham’s Law
Gresham’s Law is an economic principle stating that “bad money drives out good money.” It posits that if two coins are in circulation, both accepted as having the same nominal value but made of different metals (e.g., gold and silver), the coin made from the more valuable metal will be hoarded and the coin made from the less valuable metal will be used for transactions. This leads to the more valuable coin being driven out of general circulation.
Examples
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Historical Coinage:
In the 16th century, England experienced a blend of expensive gold coins and cheaper silver coins. People tended to hoard gold coins because they retained intrinsic value, whereas silver coins were used for daily transactions, thus driving gold coins out of circulation.
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Modern Currency:
Consider a hypothetical country where two types of paper money exist: new, robust currency and old, worn-out currency. If both are accepted at the same face value, high-quality notes might be saved while the old, less-desirable notes are spent more frequently.
Frequently Asked Questions (FAQs)
What does Gresham’s Law explain?
Gresham’s Law explains why more valuable currency often disappears from everyday use, as people prefer to spend money that has lesser intrinsic value and save valuable currency.
Is Gresham’s Law relevant today?
Yes, it applies in scenarios involving different forms of payment with different intrinsic values, like digital versus physical money, or during times of rapid inflation.
Can Gresham’s Law apply to non-monetary assets?
While its application is mostly in currency, a modified version can apply to other assets where legal and market values conflict.
How can Gresham’s Law be prevented?
Ensuring all forms of currency have similar intrinsic and market values can prevent Gresham’s Law from making one type of money hoarded and another one spent.
Commodity Money
Money whose value comes from a commodity of which it is made, such as gold or silver coins.
Fiat Money
Currency that has value because of government regulation or law, not because of its intrinsic value.
Legal Tender
Money that must be accepted if offered in payment of a debt.
Hoarding
Accumulating money or valuables and keeping them in reserve.
Market Value
The amount for which something can be sold in a given market.
Online References
- Investopedia on Gresham’s Law
- Wikipedia Article on Gresham’s Law
Suggested Books for Further Studies
- “Money Mischief: Episodes in Monetary History” by Milton Friedman.
- “Economics in One Lesson” by Henry Hazlitt.
- “The Wealth of Nations” by Adam Smith.
- “Principles of Economics” by N. Gregory Mankiw.
Fundamentals of Gresham’s Law: Economics Basics Quiz
### Which statement best describes Gresham's Law?
- [ ] Good money drives out bad money.
- [x] Bad money drives out good money.
- [ ] New money drives out old money.
- [ ] Digital money drives out physical money.
> **Explanation:** Gresham's Law states that bad money (with less intrinsic value) drives out good money (with more intrinsic value) from circulation.
### What happens to more valuable coins under Gresham's Law?
- [x] They are hoarded.
- [ ] They are spent frequently.
- [ ] They are devalued by the government.
- [ ] They disappear entirely.
> **Explanation:** Under Gresham's Law, more valuable coins are hoarded as people prefer to spend coins with lesser value.
### How does Gresham's Law affect the supply of currency in circulation?
- [ ] Increases the overall supply of currency.
- [ ] Makes no impact on circulation.
- [x] Decreases the presence of valuable currency in circulation.
- [ ] Equalizes the value of all currencies.
> **Explanation:** Gresham's Law decreases the presence of valuable currency in circulation because people hoard the valuable currency and spend the less valuable currency.
### What type of money is typically impacted by Gresham's Law?
- [ ] Fiat money alone.
- [ ] Digital money alone.
- [x] Commodity money.
- [ ] Government-backed money.
> **Explanation:** Commodity money, which has intrinsic value based on the material it is made from (e.g., gold and silver), is typically impacted by Gresham's Law.
### Can Gresham's Law apply to modern paper currencies?
- [ ] No, it only applies to coins.
- [x] Yes, in certain inflationary conditions.
- [ ] No, modern economics nullifies it.
- [ ] Yes, but only in small economies.
> **Explanation:** Gresham's Law can apply to modern paper currencies, especially in scenarios where some paper notes are more desirable than others due to inflationary conditions or physical condition.
### Who originally formulated Gresham's Law?
- [ ] John Maynard Keynes.
- [ ] Alfred Marshall.
- [x] Sir Thomas Gresham.
- [ ] Adam Smith.
> **Explanation:** Though the principle was known earlier, the law is named after Sir Thomas Gresham, an adviser to Queen Elizabeth I, who articulated it clearly in the 16th century.
### What behavior describes the public reaction predicted by Gresham's Law?
- [ ] Using good money and hoarding bad money.
- [x] Using bad money and hoarding good money.
- [ ] Treating all forms of money equally.
- [ ] Exchanging money without concern for value.
> **Explanation:** According to Gresham's Law, the public will use bad money for transactions and hoard good money.
### In the context of Gresham's Law, what is meant by 'bad money'?
- [x] Money with less intrinsic value.
- [ ] Counterfeit money.
- [ ] Highly inflated money.
- [ ] Old and worn-out money.
> **Explanation:** 'Bad money' refers to money with less intrinsic value compared to the face value, often because it is made of less valuable materials.
### What is one solution to prevent the effects predicted by Gresham's Law?
- [ ] Increase the production of more valuable currency.
- [ ] Restrict financial markets.
- [x] Ensure all forms of currency have similar intrinsic and market values.
- [ ] Encourage hoarding of valuable money.
> **Explanation:** Ensuring all forms of currency have similar intrinsic and market values helps prevent one type of money from being hoarded while the other is spent.
### Which historical period is most commonly referred to when illustrating Gresham's Law?
- [ ] The Great Depression.
- [ ] The Industrial Revolution.
- [x] The 16th Century in England.
- [ ] World War II.
> **Explanation:** The 16th Century in England frequently illustrates Gresham's Law, where gold and silver coins circulated at the same nominal value but their intrinsic values diverged.
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