Understanding Money: Functions, Types, and Role in Economy
The Essence of Money
Money is any instrument generally accepted as a medium of payment.
Conditions for Money:
- Relatively scarce with a stable value over time.
- Durable and resistant to damage.
- Easily transferable and divisible.
- Units are identical.
Role of Money
The main functions of money are to facilitate exchanges, measure value, and serve as a store of value:
Medium of Exchange
Money serves as a medium of exchange because it facilitates the exchange of goods and services. People use money to exchange it for goods, services, labor, etc.
Money simplifies exchanges and eliminates the inconvenience of barter.
In a barter economy, a double coincidence of wants is necessary for a transaction to occur. However, with a universally accepted medium of exchange (money), transactions become easier, increasing overall satisfaction.
With money, individuals can sell directly to buyers and purchase directly from sellers.
Unit of Account
Money serves as a unit of account, providing a standard for pricing goods and services. In the Eurozone, the euro is the unit of account, and prices are denominated in euros. Historically, during the time of Mercantilism (XVI-XVIII centuries), prices were often expressed in terms of gold, silver, or other precious metals.
Store of Value
Money must be a reliable store of value for people to accept it and make purchases. While money is a store of value, other assets like houses or company shares can also serve this purpose, sometimes even better.
Classes of Money
Full-bodied or Commodity Money
Its value as a monetary unit equals the value of the underlying commodity.
Metallic Money
Full-bodied money where the underlying commodity is a precious metal.
Convertible Money
Money convertible into goods whose intrinsic value is much smaller than its monetary value.
Trustee or Sign Money
Based on the confidence in the issuer.
Paper Money
Trust money embodied in paper, also called legal tender.
Bank Money
Formed by deposits in banks and other financial institutions.