Functions of Money

Money

 

Money must fulfil four functions if it is to be considered money

1 – Act as a medium of exchange.

This means it can be used to buy and sell goods and services.

This is obviously vital, if I am selling a good or service I will only accept the ‘money’ someone offers for that good or service if I can go and use that same ‘money’ to buy things myself.

If money does not meet this condition we would to rely on barter as the alternative.

Barter is when instead of offering money as a medium of exchange you will use other goods or services. Basically ‘swapping’ goods or services, I will give you 3 apples and you give me a loaf of bread.  Barter is slow and unreliable as it relies on both buyer and seller having thing which the other wants; this is called a mutual coincidence of wants.

2- Money must act as a unit of account

Money should allow you to compare the value of two very different objects.

For example if an Ipod is being sold for £100 and a pair of jeans are being sold for £50. You can now easily tell that the Ipod is valued at two pairs of jeans.

Money therefore allows you to quickly assess the opportunity cost of your decisions.

3- Money must act as a store of value

This means money must not lose value over time.

If I get paid today but I don’t intend to buy anything till the end of the week I need to be confident that the money I got will still be of use at the end of the week. If it loses its value then my work was pointless.

When money does lose this characteristic people often asked to be paid with a good they can then use for barter. I will accept a 2 kilos of rice for my days work because I then either eat it or barter with it later.

4- A standard for deferred payment

You can lend someone money today and, provided the previous three characteristics all hold, you can get it back with interest later.

This allowsfor credit which massively increases the rate of investment and growth in the economy.

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