Money

Definition of Money

Let's take a look at economic definition of money:

Currency vs Money

Money and currency often seem interchangeable, but they hold unique roles in the economic system. Think of money as a concept: it's a medium of exchange that allows us to purchase goods and services without needing to swap items directly. On the other hand, currency is a physical representation of money, like coins and bills, that a government has declared legal tender.

There are also two groups that money is split into. We call these groups M1 and M2. M1 is composed of actual currency, which is paper money and coins, and checkable deposits which are deposits made into commercial banks into either checking or savings accounts that can be withdrawn. M2 includes M1 and near-monies which are assets that are highly liquid that cannot be used as money directly but can be converted into usable money rather quickly.

Fig 1. Components of M1 and M2

Economics of Money

The economics of money, also known as monetary economics, is a branch of economics that examines the various theories behind money, and how money functions. The economics of money looks into the different types of money and how it works as a form of compensation. It also examines how monetary policy affects the economy and can be used to improve efficiency. A goal of monetary policy is to help an economy maintain stability, grow, and develop. Money is an important factor in the economy not just from an economic standpoint but also from a personal one. It is economically important because it pushes economic growth and stimulates the economy to be more productive. On a personal level, it allows society to purchase what it needs such as food, shelter, and healthcare.

Characteristics of Money

The characteristics of money are what give money its value. In this case, money is currency. The three main characteristics are its acceptability, its status as legal tender, and its relative scarcity. The benefit of money is that it is portable and replaces the need to carry around tradable goods such as gold, furs, or spices which are heavy and can go bad over time. Having a paper note or lighter coin that has a standardized value and is widely accepted makes trading infinitely easier. This standardized value also means that it can be easily divided into smaller units of account such as halves, quarters, fifths, and tenths.

Acceptability

The acceptance of cash or checkable deposits as compensation or money is partially what gives it its value. Acceptance is the first step to legitimizing anything as money because if a government or a society does not want to accept the money as payment, this suggests that it does not hold value or at least is not in a form that is acceptable to them.

Legal Tender

The second characteristic of money is its use as legal tender. This is when money has been backed by a government as a legal form of payment for any personal or private debts. This adds to the credibility and acceptability of money. U.S. Dollars all have the phrase, "this note is legal tender for all debts, public and private," written on them.

Relative Scarcity

Another characteristic of money is its relative scarcity. Money also follows the rules of supply and demand. The amount of money demanded is determined by the volume of transactions conducted in the economy and by the amount of money people want to hold as savings. With a consistent level of demand, the amount of money supplied will determine the value of money. There is no unlimited supply of money, it is supplied based on the level of purchasing power that the authorities want it to have.

Uses of Money

The uses of money are determined by the various tasks required to complete. There are six main uses or functions of money:

Medium of Exchange

A medium of exchange is an instrument used to facilitate the exchange of goods and services. Money is a medium of exchange because it allows one party to compensate another without the complication of bartering.

Store of Value

Money is a store of value because people can hold on to it for the future and expect it to maintain its value. Providing that inflation is low or nonexistent, storing wealth in the form of money is considered risk-free.

Unit of Account

Money allows us to state wealth in terms of a monetary unit rather than the goods owned or produced. We can use the units of money to record the numerical value of goods to compare them to other goods that would otherwise be difficult to compare, such as a car to 1 year of private school.

Measure of Value

Money can serve to quantify the value of a good or service, and it makes it easier to compare the value of incomparable goods, such as an apple to a gallon of gas.

Basis of Credit

Since money can be used to make purchases, it can also be loaned out. If goods had to be compensated for immediately, people would have a lot harder time making large purchases like houses and cars. Other goods could be loaned out or used to repay a loan, but it would be much more complicated because those goods may not be uniform.

Standard of Postponed Payment

This is similar to money being a basis of credit and money being a medium of exchange. For more expensive purchases, money can be paid in instalments over time, and the payment over time won't become a burden to the lender or the borrower. For example, A florist agrees to provide one bouquet every week for six months to get his house painted. After two months, the painter doesn't want any more bouquets but still requires compensation.

Money is used all around the world for many different reasons. The uses mentioned in Table 1 are the formal uses that we learn in economics. If we want to learn about the uses of money in a more personal way we can look at how we use money in our own lives. Most people interact with money in one form or another every day. We may go to work and earn a wage. We need to go grocery shopping and buy food. Maybe, we stopped at the corner store to buy a candy bar for $1 or we borrowed $10 from a friend that we have to pay them back for today. We earn, spend, and save money nearly every day of our lives.

Money is useful for completing all of these tasks of daily life since it simplifies exchanges and interactions by being a medium of exchange when buying goods and services. It is a store of value when we drop our change into our piggy bank. It is a store of value and unit of account when we take our wages to the grocery store to buy food.

Classification of Money

There are four categories of money. They are fiat money, commodity money, fiduciary money, and commercial bank money. Depending on a nation's economic and political system, the society uses the types of money that best suit their transactions.

Of the different types of money, fiat money and commercial bank money are what the modern world is most familiar with since they are what are currently in use in developed nations such as the U.S. and European countries. Commodity money was often used in the past when societies were moving away from strict bartering systems and moving toward more convenient ways to engage in trade.

Example of Money

Let's take a look at an example of money. There are many different shapes and forms that money can take all around the world. Different nations use different currencies to represent their nation's wealth.

The United States is not the only country that uses its currency. Several countries like Ecuador, Panama, and Puerto Rico use the U.S. Dollar instead of a unique currency because the U.S. Dollar is stable and backed by a stronger economy, providing those nations with stability. Other nations choose to band together to share a currency to achieve a more stable economy with their common trading partners and promote collective economic growth and integration. An example of this would be the Eurozone.