MONEY AND ITS FUNCTIONS

ENGLISH FOR THE MASTER’S PROGRAMM

 

Economics offers various definitions for money, though it is now commonly defined by its functions. In common usage, money refers more specifically to currency, particularly the many circulating currencies with legal tender status conferred by a national state; deposit accounts denominated in such currencies are also considered part of the money supply, although these characteristics are historically comparatively recent. Other older functions money may possess are a means of rationing access to scarce resources, and a means of ac­cumulating power of command over others.

Although the crucial feature of money is its acceptance as the means of payment or medium of exchange, money has other functions. It serves as a unit of account, a store of value and as a standard of deferred payment.

Money, the medium of exchange, is used in one-half of almost all exchange. Workers exchange labour services for money. People buy and sell goods in exchange for money. People accept money not to consume it directly but because it can subsequently be used to buy things they do wish to consume. To see the advantages of a medium of exchange, imagine a barter economy, that is, an economy having no medium of exchange. Goods are traded directly or swapped for other goods. The seller and the buyer each must want something the other has to offer. Each person is simultaneously a seller and a buyer. In order to see a film, you must hand over in exchange a good or service that the cinema manager wants. There has to be a double coincidence of wants. Trading is very expensive. People must spend a lot of time and effort finding others with whom they can make mutually satisfactory swaps. The closer is the economy to the barter type, the more wasteful it is. The use of money — any commodity generally accepted in payment for goods, services, and debts — makes the trading process simpler and more efficient.

The second function of money is to serve as a unit of account. A unit of account is a yard­stick for measuring prices and values and a benchmark for comparing them. In principle, any commodity can serve as a unit of account. Having chosen the good, we can express the price of each of the rest of the goods in units of that good. Historically, societies designated a single item to serve as the unit of account, say, a kilogram of wheat. In this way, each good could be priced at so many kilograms of wheat per unit. In modern times, paper money is the unit of account. For example, the dollar is the unit of account in the United States. Knowing that a pound of peaches costs two dollars and a pound of apples costs one dollar enables us to compare their value. Thus, money becomes a standard of value.

Normally, the same item serves as the unit of account and the medium of exchange: the dollar in the United States; the yen in Japan; the mark in Germany. In abnormal times, however, societies divorce the two functions of money, often unofficially. For example, although the ruble is the unit of account in Russia, some Russians use foreign currencies, such as the dollar and the mark, as the unofficial medium of exchange. Many Russians, without access to foreign currencies, resort to barter. Invariably, the reason for the divorce of the medium of exchange from the unit of account is a deterioration of the currency as a store of value, which takes us to the third function of money.

A store of value is a reservoir of future purchasing power. Money is both a temporary and a permanent store of purchasing power. The function of money as a temporary store of purchasing power is an outgrowth of its function as a medium of exchange. If an item is to serve as a medium of exchange, people must hold that item to carry out their transac­tions. For example, consider an individual who earns $700 a week but plans to spend $560 on goods and services and save $140 every week. Usually this individual will not spend the entire $560 on payday. Instead, he may spend $90 on payday and hold $470 in the form of money to be spent over the course of the week. This $470 held in money is a temporary store of purchasing power.

People, however, hold more money than they need to carry out their transactions. Why? The answer is that money can also serve as a permanent store of purchasing power. Individu­als who save forgo present consumption to have higher future consumption. The wealth of individuals is their accumulated savings. Money is one form in which individuals may keep their wealth; stocks, bonds, and real estate are other forms. Of course, when wealth is held in money, in the future it will not need to be exchanged to buy goods and services. The ability of money to serve as a store of value depends on its capacity to retain its purchasing power.

Finally, money serves as a standard of deferred payment or a unit of account over time. When you borrow, the amount to be repaid next year is measured in pounds sterling or in some other hard currency. Although convenient, this is not an essential function of money. UK citizens can get bank loans specifying in dollars the amount that must be repaid next year.

Thus the key feature of money is its use as a medium of (exchange). For this, it must act as a store of value as well. And it is usually, though not invariably, convenient to make money the unit of account and standard of deferred payment as well.