What Are The Four Functions Of Money

Chapter 27. Money and Banking

27.1 Defining Money by Its Functions

Learning Objectives

By the terminate of this department, yous volition be able to:

• Explain the diverse functions of money
• Contrast commodity money and fiat money

Money for the sake of money is not an end in itself. You cannot eat dollar bills or wear your bank account. Ultimately, the usefulness of coin rests in exchanging it for goods or services. As the American author and humorist Ambrose Bierce (1842–1914) wrote in 1911, money is a "blessing that is of no reward to us excepting when nosotros part with it." Money is what people regularly utilise when purchasing or selling goods and services, and thus money must exist widely accepted past both buyers and sellers. This concept of coin is intentionally flexible, because coin has taken a wide variety of forms in different cultures.

Barter and the Double Coincidence of Wants

To understand the usefulness of coin, we must consider what the world would be like without money. How would people commutation goods and services? Economies without money typically engage in the barter organization. Barter—literally trading i good or service for another—is highly inefficient for trying to coordinate the trades in a modern avant-garde economy. In an economy without money, an substitution between ii people would involve a double coincidence of wants, a situation in which two people each want some good or service that the other person tin provide. For case, if an accountant wants a pair of shoes, this accountant must find someone who has a pair of shoes in the correct size and who is willing to exchange the shoes for some hours of bookkeeping services. Such a trade is likely to be difficult to adapt. Call up near the complexity of such trades in a modern economy, with its all-encompassing segmentation of labor that involves thousands upon thousands of different jobs and goods.

Another trouble with the barter system is that it does not allow us to easily enter into hereafter contracts for the buy of many appurtenances and services. For case, if the appurtenances are perishable information technology may be difficult to exchange them for other goods in the future. Imagine a farmer wanting to buy a tractor in six months using a fresh crop of strawberries. Additionally, while the castling system might work adequately in small economies, it will keep these economies from growing. The time that individuals would otherwise spend producing appurtenances and services and enjoying leisure time is spent bartering.

Functions for Money

Money solves the problems created past the barter organisation. (We will go to its definition before long.) Beginning, money serves as a medium of exchange, which means that money acts as an intermediary between the buyer and the seller. Instead of exchanging accounting services for shoes, the auditor now exchanges accounting services for money. This coin is and so used to purchase shoes. To serve every bit a medium of exchange, money must be very widely accustomed as a method of payment in the markets for appurtenances, labor, and financial capital.

Second, money must serve as a store of value. In a barter organisation, nosotros saw the case of the shoemaker trading shoes for accounting services. But she risks having her shoes go out of style, especially if she keeps them in a warehouse for future use—their value will decrease with each season. Shoes are non a good store of value. Holding coin is a much easier manner of storing value. You know that you exercise not need to spend it immediately considering it will all the same concur its value the next day, or the next year. This function of money does not require that money is a perfect store of value. In an economic system with inflation, money loses some buying power each year, merely it remains money.

Third, coin serves as a unit of measurement of account, which means that it is the ruler by which other values are measured. For example, an accountant may accuse $100 to file your taxation return. That $100 can purchase ii pair of shoes at $l a pair. Money acts as a mutual denominator, an accounting method that simplifies thinking about trade-offs.

Finally, another office of money is that money must serve as a standard of deferred payment. This means that if money is usable today to make purchases, it must also exist adequate to brand purchases today that will be paid in the time to come. Loans and future agreements are stated in monetary terms and the standard of deferred payment is what allows the states to buy appurtenances and services today and pay in the future. So coin serves all of these functions— it is a medium of commutation, store of value, unit of measurement of account, and standard of deferred payment.

Commodity versus Fiat Money

Money has taken a wide variety of forms in different cultures. Gold, silverish, cowrie shells, cigarettes, and even cocoa beans accept been used as money. Although these items are used every bit article money, they too have a value from use as something other than money. Gold, for example, has been used throughout the ages as coin although today it is not used every bit money but rather is valued for its other attributes. Gold is a good conductor of electricity and is used in the electronics and aerospace industry. Gold is also used in the manufacturing of free energy efficient cogitating glass for skyscrapers and is used in the medical industry as well. Of form, gold too has value because of its beauty and malleability in the creation of jewelry.

As commodity money, gold has historically served its purpose every bit a medium of substitution, a store of value, and as a unit of measurement of account. Commodity-backed currencies are dollar bills or other currencies with values backed up by gold or other article held at a bank. During much of its history, the coin supply in the United states of america was backed by aureate and silver. Interestingly, antiquarian dollars dated as late as 1957, have "Silver Document" printed over the portrait of George Washington, as shown in Figure 1. This meant that the holder could have the bill to the appropriate bank and exchange it for a dollar's worth of silver.

Effigy i. A Silver Certificate and a Modernistic U.South. Bill. Until 1958, silver certificates were article-backed money—backed by silver, as indicated by the words "Silver Certificate" printed on the pecker. Today, U.S. bills are backed past the Federal Reserve, but as fiat coin. (Credit: "The.Comedian"/Flickr Creative Eatables)

As economies grew and became more global in nature, the employ of article monies became more cumbersome. Countries moved towards the employ of fiat money. Fiat coin has no intrinsic value, only is declared by a authorities to exist the legal tender of a country. The United States' paper money, for case, carries the statement: "THIS Notation IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE." In other words, by regime decree, if you lot owe a debt, so legally speaking, you can pay that debt with the U.South. currency, even though it is non backed past a article. The merely backing of our money is universal religion and trust that the currency has value, and naught more than.

Watch this video on the "History of Coin."

Key Concepts and Summary

Money is what people in a society regularly use when purchasing or selling goods and services. If coin were not bachelor, people would need to barter with each other, meaning that each person would need to identify others with whom they take a double coincidence of wants—that is, each party has a specific practiced or service that the other desires. Money serves several functions: a medium of exchange, a unit of account, a shop of value, and a standard of deferred payment. There are ii types of money: commodity coin, which is an item used every bit money, just which also has value from its use as something other than money; and fiat money, which has no intrinsic value, but is declared by a government to be the legal tender of a country.

Self-Check Questions

1. In many casinos, a person buys chips to use for gambling. Within the walls of the casino, these chips can oft be used to buy food and drink or even a hotel room. Exercise chips in a gambling casino serve all 3 functions of money?
2. Can you name some item that is a store of value, but does not serve the other functions of money?

Review Questions

1. What are the iv functions served by money?
2. How does the being of money simplify the process of ownership and selling?
3. What is the double-coincidence of wants?

Critical Thinking Questions

1. The Bring it Home Feature discusses the employ of cowrie shells equally money. Although cowrie shells are no longer used as money, do you recollect other forms of commodity monies are possible? What role might applied science play in our definition of money?
2. Imagine that yous are a barber in a world without money. Explain why it would be catchy to obtain groceries, clothing, and a place to alive.

References

Hogendorn, January and Marion Johnson. The Shell Coin of the Slave Trade. Cambridge Academy Press, 2003. 6.

Glossary

barter

literally, trading ane good or service for another, without using money

commodity money

an item that is used as money, just which likewise has value from its employ every bit something other than coin

commodity-backed currencies

are dollar bills or other currencies with values backed up by gilt or some other commodity

double coincidence of wants

a situation in which two people each want some adept or service that the other person tin can provide

fiat money

has no intrinsic value, just is declared by a government to exist the legal tender of a land

medium of exchange

any is widely accepted as a method of payment

coin

whatsoever serves guild in iv functions: as a medium of commutation, a store of value, a unit of business relationship, and a standard of deferred payment.

standard of deferred payment

money must too be acceptable to make purchases today that will be paid in the time to come

store of value

something that serves every bit a style of preserving economic value that tin be spent or consumed in the future

unit of measurement of business relationship

the mutual way in which market place values are measured in an economy

Solutions

Answers to Cocky-Check Questions

1. As long every bit you remain inside the walls of the casino, chips fit the definition of money; that is, they serve every bit a medium of exchange, a unit of business relationship, and a store of value. Chips do non work very well as money once you leave the casino, but many kinds of money do not work well in other areas. For case, it is hard to spend money from Turkey or Brazil at your local supermarket or at the movie theater.
2. Many physical items that a person buys at one fourth dimension but may sell at another time tin serve equally an answer to this question. Examples include a house, land, art, rare coins or stamps, and so on.

Source: https://opentextbc.ca/principlesofeconomics/chapter/27-1-defining-money-by-its-functions/

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