The Nature of Money
- Money oils exchange: because sellers will accept it, a buyer need not find someone wanting exactly what they offer.
- Economists identify four functions of money: medium of exchange, unit of account, store of value and standard of deferred payment.
- Barter instead needs a double coincidence of wants, so search costs rise and complex trade slows sharply.
- To perform its functions well, money must be durable, portable, divisible, acceptable, scarce and uniform.
Definition
Money: anything widely accepted in final settlement of a debt or in payment for goods and services.
Barter: the direct exchange of one good or service for another without using money.
Double coincidence of wants: the need in barter for each trader to have exactly what the other wants.
Key Idea
- Functions describe what money does; characteristics describe why an asset can do it.
- Barter is inefficient because it needs a double coincidence of wants.
- Over-issue erodes scarcity, so each unit of money buys less.
The Four Functions
Definition
Medium of exchange: money handed over to complete a transaction, so barter is avoided.
Unit of account: a common measure in which all prices are quoted and compared.
Store of value: money that holds purchasing power to be spent later.
Standard of deferred payment: money used to settle debts repaid in the future.
- As a medium of exchange, a £20 note settles a shop purchase in one step, so resources move to their most valued use.
- As a unit of account, quoting a car at £15,000 and a coffee at £3 lets buyers compare value instantly.
- As a store of value, saving £500 only works if prices are stable, since inflation eats real value away.
- As a standard of deferred payment, a £200,000 mortgage is agreed today and repaid over 25 years.
Example
- Suppose annual inflation is 10% and a household holds £100 in cash for a year.
- So the £100 buys only about £90.90 of goods after a year, weakening money as a store of value.
Desirable Characteristics
- Durability and portability: notes survive daily handling and are easily carried, so money keeps working in everyday use.
- Divisibility: because £10 splits into 10 × £1, money can price goods of very different values.
- Acceptability and uniformity: every £5 note is identical and trusted, so sellers take it without checking.
- Scarcity: if money grows far faster than output, each unit buys less, so its value falls.
Example
- Gold long served as money because it was durable, scarce and easily divided into set weights.
- Cigarettes acted as money in some prisoner-of-war camps, being portable, uniform and accepted.
- A house makes poor money: it cannot be divided or carried, so it fails the characteristics test.
Judging an Asset as Money
- Test a candidate asset against each function: can it be exchanged, priced in, stored and used for future payment?
- Then test the characteristics: is it durable, portable, divisible, acceptable, scarce and uniform?
- A bank deposit passes, because it is accepted and holds value, so it serves as money.
- It depends on context: an item can be money in one setting yet fail in another, as camp cigarettes show.
Exam technique
- Name the four functions, then explain each with a short £ example.
- Link each characteristic to the function it supports rather than listing them blindly.
- Contrast money with barter to show why a double coincidence of wants is costly.
Common Mistake
- Do not confuse functions (what money does) with characteristics (why it works).
- Do not treat scarcity as optional: without it, over-issue destroys value.
Self review
- Name the four functions of money.
- What is the double coincidence of wants?
- Name three desirable characteristics of money.
- Why does 10% inflation weaken money as a store of value?
- How would you judge whether an asset works as money?
