Functions of money

VIDEO- Watch first 5 minutes where Scrooge McDuck explains the function of money

The three main functions of money are:

1. A medium of exchange

• People use money to buy and sell goods.
• Money makes transactions easier because everyone is willing to trade money for goods and goods for money.
• A barter economy that has no money can be very inefficient because it only works when each trader wants what the other has. This is called a double coincidence of wants.
• If there is no coincidence of wants then traders spend more time seeking trades and less time producing goods.

REAL LIFE EXAMPLE- If I want to trade my Pokemon cards for lunch then I need to find someone who is willing to make this trade. If no-one wants to make the trade then I might have to make other trades to get my lunch. I might have to trade my Pokemon cards many times before I have something that I can use to trade for lunch. This wastes a lot of my time, so it would be a lot of easier if I could use money that everyone accepts.

2. A unit of account

• Money shows prices of goods in an economy
• It can be used as a simple way of comparing the value of different goods.
• It allows us to understand how much value buyers and sellers place on a good.

REAL LIFE EXAMPLE- I'm selling cupcakes for £2 each and my best friend is selling loom band necklaces for £4 each. The prices allow me to compare the value of cupcakes and loom band necklaces. Loom band necklaces are worth the same as 2 cupcakes. People are willing to give up twice as much money for a loom band necklace than they are for a cupcake.

3. A store of value

• Money can be used to store value over time
• Money retains its value longer than commodities
• Money is a near perfect store of value with the exception of inflation

REAL LIFE EXAMPLE- I want to store the value of a £2 soft whip ice cream for one week. I could just buy the ice cream now and keep it in my freezer for a week. This would be OK but it probably won't be whippy any more by the time I want to eat it. I could buy a voucher for a soft whip ice-cream, but then that will be all I can buy: I might change my mind and want to buy a Twister.

Or I could spend £2 on a book then sell it at the end of the week and use the money to buy my ice cream. But what if no one will buy the book? Then I won't be able to get my ice cream. The easiest thing for me to do would be to stash £2 and then just stroll over to buy an ice cream when I feel like it. There might be inflation, but money is still the best option I have to be able to get the ice cream at the end of the week.

Characteristics of Money

For money to be most effective, it has to be:

1. Widely accepted for goods and services for a long time

2. Durable: able to withstand being used repeatedly (so we can't use wheat, corn or rice)

3. Easy to carry

4. Divisible into smaller units of value (so artwork wouldn't work)

5. In limited supply- this is why we don't use aluminium or iron

6. Uniform – all versions of same denomination must be able to buy the same amount

7. Valued in itself- this is why we don't use ordinary paper