What is money and what functions does it perform. Money is an economic unit that functions as a generally recognized medium of exchange for transactional purposes in an economy. Money provides the service of reducing transaction cost, namely the double coincidence of wants. Money originates in the form of a commodity, having a physical property to be adopted by market participants as a medium of exchange.
Functions of Money
Money performs four main functions in today’s society. It mainly serves as:
In theory, people are generally able to exchange goods and services without the need for a monetary transaction between the parties involved. For example, a farmer can exchange 10 kilos. of apples for 10 liters of milk with another farmer.
An economy based on barter would face several restrictions:
Once we understand the limits of barter, we can easily understand the functions of money in our society.
Money as a Medium of Exchange
A medium of exchange is an asset that can be used in a transaction to exchange goods and services. Gold and other precious metals have been used as a medium of exchange before money itself, or alongside it.
Not every asset can be used as a medium of exchange. To be a proper medium of exchange, an asset must have the following characteristics:
Money as a Standard of Deferred Payment
The above function is somehow related to the first, as it creates credit and allows transactions to be settled in the future. To be a standard of deferred payment, money must be an accepted way to value and settle a debt in the future.
Money as a Store of Wealth
As services can’t be stored and a lot of goods are perishable, society requires more effective ways of storing wealth. Money can be easily stored, retrieved, and used at a later time, and, at least in times of low inflation, it’s able to maintain most of its value.
Money as a Measure of Value
Money can be used as a universal unit of account to measure the value of all the goods and services exchanged in an economy.
In a money-based economy, prices can be indicated using only one measure of value, simplifying transactions and people’s understanding of how much a good or service is worth.
Conversely, in a barter economy, the prices for a good or service should be established based on all the other goods or services produced and exchanged.
Precious Metals as Money
Especially in the past, gold and other precious metals have been successfully used as money in many societies. It is due to the following: