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Section 1 Money

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Objectives

After studying this section you will be able to:

1. Describe the three uses of money.
2. Explain the six characteristics of money.
3. Understand the sources of money's value.

Section Focus

Money serves as a medium of exchange, a unit of account, and a store of value. Although many objects have served as money in the past, the coins and bills we use today meet the needs of modern society.

Key Terms

• money
• medium of exchange
• barter
• unit of account
• store of value
• currency
• commodity money
• representative money
• fiat money

Suppose you have just arrived at your neighborhood store after playing basketball on a hot day. You grab a soda and fish around in your jeans pockets for some money. You find a pen, keys, and a chewing gum wrapper, but, unfortunately, no money. Then you reach into your jacket pocket. Finally!—a crumpled dollar bill. You hand the money to the clerk and take a long, cold drink.

Money is a part of our daily lives. Without it, we can't get the things we need and want. That's not the whole story of money, however. In fact, money has functions and characteristics that you might never have thought about.

The Three Uses of Money

If you were asked to define money, you would probably think of the coins and bills in your wallet or the paychecks you receive for your part-time job. Economists define money in terms of its three uses. For an economist, money is anything that serves as a medium of exchange, a unit of account, and a store of value.

Money as a Medium of Exchange

A medium of exchange is anything that is used to determine value during the exchange of goods and services. Without money, people acquire goods and services through barter, or the direct exchange of one set of goods or services for another. Barter is still used in many parts of the world, especially in traditional economies in Asia, Africa, and Latin America. It is also sometimes used informally in the United States. For example, a person might agree to help paint a neighbor's house in exchange for vegetables from the neighbor's garden. In general, however, as an economy becomes more specialized, bartering becomes too difficult and time-consuming to be practical.

To appreciate how much easier money makes exchanges, suppose that money did not exist, and that you wanted to trade your video cassette recorder (VCR) for an audio CD player. You probably would have a great deal of trouble making the exchange. First, you would need to find someone who wanted to both sell the model of CD player you want and buy your particular VCR. Second, this person would need to agree that your VCR is worth the same as his or her CD player. As you might guess, people in barter economies spend a great deal of time and effort exchanging the goods they have for the goods they need and want. That's why barter generally works well only in small, traditional economies.

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