Money: What is it? How is it defined? and What are its Functions? -From the Economics Page!

The concept of money is actually very interesting. We look in our wallet and see wealth (or nothing like me) when in fact the paper you hold is only worth $0.06 per bill. So how do we make money have value, what is money and how is it created?

Read on to learn the answers:

What is Money and why do we need it?

Money is assets that people are generally willing to accept in exchange for goods and services or for payment of debts. Basically, money is an accepted medium for exchange. There are also two types of money.

The first is commodity money. This is "an item (i.e.- gold or silver) which meets the criteria for a medium of exchange for both the issuer and receiver of the money."

The next form of money is called fiat money. This is "money, such as paper currency, that is authorized by a central bank or government body and that does not have to be exchanged by the central bank for gold or some other commodity money." This is the form of money nearly every nation in the world uses, however in some places both are often utilized.

Now do we need money? The answer is no. For thousands of years many have bartered, one starting low and the other high, until and mutually agreed amount of item X is determined. A great example of this is in Tonga where there is a brides fee for marrying a mans daughter. Many do not have money so they pay cows instead.

So, What are the Functions of Money?

The functions of money are broken down into two components: at the current point of sale, and a long term value.

At a current time, or point of sale, money serves as a medium of exchange when sellers are willing to accept it in exchange for goods and services. Also, money is used as a unit of account. This is were in a barter economy each good has many prices.

In a long term perspective money acts as a store of value. This is if you do not use all your accumulated dollars to buy goods and services today, then you can hold the rest to use in the future. This is better in many cases such as with a farmer who's goods he has to trade with are perishable whereas fiat money is not. Lastly, money can serve as a standard of deferred payment which we see commonly today with borrowing and lending.


How is Money Measured in the U.S. Today?

The Money Supply is viewed in two ways, M1 and M2.

M1 is the narrowest definition of the money supply and is "the sum of currency in circulation, checking accounts, and holdings of traveler's checks." Currency is all paper money and coins that are in circulation, meaning all tangible money and coins not held by banks or the government. Checking accounts simply are checking account deposits in banks. Also, it should be noted that in May 2007, the total sum of all travelers checks in circulation only valued $7 billion, thus this item may often be ignored in calculations and common discussion.

M2 is a much broader definition of money. This involves "All the components in M1 plus savings account balances, small-denominational time deposits, balances in money market deposit accounts in banks, and non-institutional money market fund shares."


Now that we know everything we can do with money,
What can Serve as Money?

That is, which asset should be used as the medium of exchange? We saw earlier that an asset must, at a minimum, be generally accepted as payment to serve as money. In particular terms, however, it must be even more.
Five criteria make a good suitable to use as a medium of exchange:

1. The good must be acceptable to (that is, usable by) most people.
2. It should be of a standardized quality so that any two units are identical.
3. It should be durable so that the value is not lost by spoilage.
4. It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported.
5. The medium of exchange should be divisible because different goods are valued differently.



GREAT! So now you know all about money. I hope you enjoyed it. Come back soon to learn about how money is created by banks. Also, if you have any further questions, please e-mail me below. Thanks,

Kyle W. Gay
kylewgay@gmail.com

Note, my primary source for this post came from "Economics, 2nd edition" by Hubbard and O'Brien. Secondary sources are my personal knowledge and notes form economics classes i have taken at Elon university.