Can someone explain Gresham's law to me in simple terms with a good example.?

Answer 1

Basically if good (money that keeps its value) and bad (money that doesn't) is made BY LAW to legally be in circulation at once, the bad money will make the good money stop circulating.

Take for instance a person going to a shop, buying an item and having the choice of paying with GOOD or BAD money. She will want to pay with the BAD because she wants the GOOD for herself. The shopkeeper will also want to keep his GOOD money, so he'll give the change in BAD money.

That means that the GOOD money will be hoarded and so is driven out of circulation.

An instance would be for example when paper money (bad) and gold (good) were being changed over. Obviously the paper money would be more popular as people hoarded the gold.
Hope that makes sense.

Answer 2

Gresham's law means that good money will drive out bad. Take a bi-metallic standard (one i which gold and silver coins circulate freely, but the government has declared an arbitrary relationship). Various times in US history apply here. Instead of allowing the marketplace to determine the ratio of gold to silver (and the price of each), the government would simply declare for example, that one ounce of silver would be worth 1/16 once of gold. Well, when supply of the metals shifted, so would the real price. Say that a new supply of gold was found, and the natural price would go to 1 oz silver = 1/2 ounce of gold (i.e., because supply has increased, the price in terms of silver has fallen). Because government works slowly, they are still coercing people to accept as legal tender gold at the higher price. It becomes profitable for people to melt down silver, sell it internationally (where 1 oz fetches them 1/2 an oz of gold) and bring the gold home to pay debts or taxes (where that same 1/2 oz of gold is accepted as being the same as 8 oz of silver). Presto chango, 1 oz becomes 8! The undervalued currency (in this example, gold) disappears from circulation as people export it. The overvalued currency still circulates freely. Thus, the overvalued currency (bad) drives out the undervalued currency (good). Note that Gresham's law only kicks in when the price of goods is set by decree, and not the market. Had the two been allowed to fluxuate naturally, the values would simply have been changed as the new gold entered into the market. For more examples) and an excellent treatise on money) read Murray N. Rothbard's History of Money and Banking in the United States.

Answer 3

Pretty simple...

The premise here is that you'd have a market economy with two types of money. One type ("good money") is roughly equal to its commodity. For instance, the US dollar (prior to the 1990's, anyway) was rougly worth the same as its gold counterpart.

The other type ("bad money") is money that is worth way less than its backing commodity. Debased coinage is a good example of "bad" money. Back when coins were made of silver and gold, people would "debase" them or trim pieces off of the sides of the coins to make new coins. In this way, you could have 120 "bad" coins made out of 90 "good" (or non-debased) coins.

Now, Gresham's law simply states that in an economy with both kinds of money, people will spend the "bad" money and keep the "good" money for themselves, therefore further spreading "bad" money throughout the market.

See: http://en.wikipedia.org/wiki/Gresham's_Law for some good examples and a more in-depth explanation.

Hope this helps!