Money

The essentials

In a barter system, goods are exchanged directly for goods. Barter suffers from several problems: it needs a double coincidence of wants (each party must want what the other has), there is no common measure of value, goods may be indivisible, and it is hard to store wealth or settle future payments. Money is anything generally accepted as a medium of exchange and a measure of value. It removes these difficulties.

Key points

• Medium of exchange: money is accepted in exchange for goods and services, so selling and buying become separate acts.
• Unit of account (measure of value): the values of all goods are expressed in money, making comparison easy.
• Store of value: wealth can be held in money for future use, since money does not perish.
• Standard of deferred payment: loans and future payments can be settled in money.
• Fiat money: currency notes and coins issued by the authority of the government and central bank; it has value because of legal backing, not because of the material it is made of.
• Legal tender: money that cannot be refused in settlement of payments (currency notes and coins). Cheques and demand deposits are not legal tender, though widely used.
• People demand money for transactions (to make day-to-day payments) and as an asset (speculative motive), which depends inversely on the rate of interest.

Exam tips

Match each function to an example: paying a shopkeeper (medium of exchange), a price tag (unit of account), keeping savings in cash (store of value), repaying a loan next year (deferred payment).

Common mistakes

• Calling demand deposits legal tender.
• Saying money has intrinsic value; modern money is fiat money.