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There is one major difference between M1 and M2. The main difference is that M1 is a more limited and more liquid type of money. More types of money are included in M2, but they are less liquid than those included in M1.
Different kinds of money can be more or less liquid. This means that they can be more or less usable for buying goods and services. For example, cash and deposits in checking accounts are extremely liquid. These, along with travelers’ checks (which used to be a more important form of money) make up M1.
M2 includes all of M1. However, it also includes other, less liquid, forms of money. This includes such things as deposits in savings accounts, money market accounts, and money market mutual funds. It also includes money in certificates of deposit (CDs). These types of money are relatively liquid, but are slightly more difficult to actually use than the money in M1 is.
Thus, the major difference between these two is that M1 is more liquid while M2 includes more kinds of money but is less liquid.
Not only in economics, but M1 and M2 are important to understand for the pure sake of consuming. M1 and M2, while both are representations of money, differ quite significantly.
I will start with M1. M1 is physical money supply. This can include any of the following: cash, coins, demand deposits, traveler's checks, and even checking accounts. M1's most important quality to understand, is the quickness and ease of transfer from accounts and assets to physical currency. Also known as liquidity, it is very easy for M1 to quickly become something you can hold in your hand. It is not "near money" as M2 might be.
With M2, not only does it include "near money," but it also includes cash and checking deposits. Near money can be looked at as anything from savings deposits, money mutual funds, and other time deposits that are less liquid and not easily transferable to physical money. M2 is never really used as a means of payment, that is all done in M1. However, M2 is important to understand because it can often serve as a legitimate way to invest, increase wealth, and even pay off loans, bills, and taxes.
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