FUNCTIONS OF MONEY

Whether money in shells or rocks or gold or paper, in any economy it has three primary functions, it is a medium of exchange, a unit of account, and a store of value. Of the three functions, its function as a medium of exchange is what distinguishes money from other assets such as stocks, bonds, or houses.

Medium of Exchange. In almost all market transactions in our economy, money in the form of currency or checks is a medium of exchange; that is, it is used to pay for goods and services. The use of money as a medium of exchange promotes economic efficiency by eliminating much of the time spent in exchanging goods and services. To see why, let's look at a barter economy, one without money in which goods or services are exchanged directly for other goods or services. Take the case of Ellen, the Economics professor, who can do just one thing well: give brilliant economic lectures. In a barter economy, if Ellen wants to eat, she must find a farmer who not only produces the food she likes, but also wants to learn economics. As you might expect, this search will be difficult and time consuming, and Ellen may spend more time looking for such an economics-hungry farmer than she will teaching. It is even possible that she will have to quit lecturing and go into farming herself. Even so, she may still starve to death.

The time spent trying to exchange goods and services is called transactions cost. In a barter economy, transactions costs are high because people have to satisfy a double coincidence of wants: that is, they have to find someone who has a good or service they want and who also wants the good or service they have to offer.

We see money promotes economic efficiency by eliminating much of the time spent exchanging goods and services. It also promotes efficiency by allowing people to specialize in what they do best. We see, therefore, that money is an essential item in an economy. It acts as a lubricant that allows the economy to run more smoothly by lowering transactions costs, thereby encouraging specialization and the division of labor.

The need for money is so strong that almost every society except the most primitive invents it. For a commodity to function as effectively as money it has to meet several criteria: (1) it must be easily standardized, making it simple to ascertain its value; (2) it must be widely accepted; (3) it must be divisible so that is easy to "make change"; (4) it must be easy to carry, and (5) it must not deteriorate quickly. Forms of money that have satisfied these criteria have taken many unusual forms throughout human history.

Vocabulary:

medium of exchange – засіб обміну

store – збереження

to distinguish – відрізняти

to promote – сприяти

to eliminate – усувати

brilliant – чудовий, яскравий

search – пошук

time consuming – той, що забирає багато часу

to quit – звільнятися

to starve – голодувати

coincidence – співпадіння

lubricant – мастило

commodity – товар

to ascertain – встановити

divisible – ділимий

to deteriorate – пошкоджуватися, зношуватися

criteria (sing. criterion) – критерії

Questions:

1. How many functions of money do you know?

2. What function of money is the most important?

3. What is money as a medium of exchange used for?

4. What do we call a transaction cost?

5. How does money promote economic efficiency?

6. What are the criteria for money?

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