Unit of Account Costs

Unit of Account Costs Definition

To understand the unit of account costs definition, let's consider how contemporary money works. Today, we are used to money operating as a unit of account. This means that money serves as objective mathematical units and is divisible, fungible, and countable. The main function of money is to serve as a unit of account, which is a standard numerical monetary unit of measurement of the price of goods and services in the economy.

In inflationary periods money loses value which leads to the unit-of-account cost of inflation.

However, due to inflation, paper money can lose its value over time which comes with costs. One of the main effects of the unit-of-account cost is that it makes economic decisions less efficient in the economy by giving rise to uncertainty in the function of money as a unit of account.

Unit of Account Costs of Inflation

Unit of account costs of inflation refers to the costs that are associated with money becoming a less reliable unit of measurement.

One weakness of transitioning from gold and silver coins to paper money was a greater tendency to experience inflation.

Paper currency inflates more quickly than gold coinage because paper money is far easier to produce. Initially, it was also much easier to counterfeit or make illegally. Bank notes and government currency could be overprinted and cause inflation through sellers charging higher prices after realizing there was more money in circulation.

• At first, governments tried to limit the overprinting of paper currency by maintaining a gold standard. The gold standard meant that each paper dollar had to be backed by a specific amount of gold, which could be held in a bank vault.
• After the end of the gold standard, governments tried to limit inflation through modern monetary policy, which meant controlling the money supply. Today, this means setting interest rates and regulating the lending practices of commercial banks.

Although there are attempts to limit inflation, it still exists, and it is present. Inflation directly impacts the unit-of-account function of money as basically all the measurements expressed in currency terms lose real value.

Unit-of-account costs have a peculiar impact on the tax system.

One of the main effects of the unit-of-account cost of inflation is the loss of real purchasing power by individuals.

Fig 1. - Money losing value as a result of inflation

Figure 1 above shows the real value of 10 euros after the economy experienced a 10% increase in inflation. Although the unit of measurement is 10, the real purchasing power of the 10 euro bill has dropped to 9, meaning that with ten euros, one could only buy actually 9 euros worth of goods, although you are paying 10.

Example of Unit of Account Cost

Examples of unit of account costs relate to the loss in real purchasing power of individuals.

Unit of Account Function of Money

The unit of account function of money is to provide objective, measurable value to different goods and services. This makes it easy to complete economic transactions, such as buying and selling.

Before money, trade occurred through a time-consuming process where goods and services were traded for other goods and services. This is known as a barter system and is very inefficient. Without objective prices or measurements, the number of goods that could be exchanged for other goods differed daily. This could lead to hostility and a breakdown of trade.

Fig 2. - US dollar

Figure 2 above shows the US dollar, which is used as a unit of account in the United States and worldwide. A major part of international trade between countries is conducted in US dollars.

Having objective units of account also allows buyers and sellers to easily determine if a trade is worth it. Buyers know how much money they have in total and can compare the price of the desired good against this total. Conversely, sellers can set a sale price that covers their production costs.

Without objective units of money, both of these would be difficult. Money that can operate as a unit of account allows for quick, rational economic decisions and for money to be spent on the most profitable endeavor. Ultimately, this leads to greater economic growth.

Menu Costs vs Unit of Account Costs

The main difference between the menu costs vs. unit of account costs is that menu cost refers to the costs businesses face when changing the nominal prices of their products due to inflation. Unit of account costs are costs that are associated with the decline in the reliability of using money as a unit of account.

Because today's money serves as an objective unit of account, prices can be adjusted periodically to deal with inflation.

In previous decades, when menus at restaurants were physically printed, these costs could be considerable. If there was high inflation, menus might need to be printed every few months so that customers would pay higher prices. Today, using electronic boards and websites for restaurant menus removes some of these costs.

Menu costs can also occur in renegotiating contracts due to inflation. While the physical printing of menus may no longer be common, negotiating business contracts remains an ongoing cost.

Shoe Leather vs Unit of Account Costs

The main difference between shoe leather vs. unit of account costs is that shoe-leather costs refer to the increased costs of transactions as a result of inflation. On the other hand, the unit of account costs refers to the costs arising because money becomes a less reliable unit of account.

Customers shop around for deals to avoid paying higher prices due to inflation. The costs incurred by shopping around are known as shoe leather costs, as in previous generations, people had to walk from store to store physically. Even in the digital era, where consumers shop for deals online rather than walking from store to store, the time costs of finding deals are equivalent to shoe leather costs.

The expansion of shopping options due to online shopping may increase shoe leather costs in the modern era by driving many consumers to spend hours on different websites and scrutinizing scores of posted reviews.

When inflation is high, consumers may feel driven to spend more time than usual searching for the optimal deal on any purchase.