Functions of Money

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.