FUNCTIONS OF MONEY
Money is often defined in terms of the three functions or services that
it provides. Money serves as a medium of exchange, as a store of value, and as a unit of account.
MEDIUM
OF EXCHANGE
Money's most important function is as a medium
of exchange to facilitate transactions. Without money, all transactions would
have to be conducted by barter,
which involves direct exchange of one good or service for another. The
difficulty with a barter
system is that in order to obtain a particular good
or service from a supplier, one has to possess a good or service of equal
value, which the supplier also desires. In other words, in a barter system,
exchange can take place only if
there is a double
coincidence of wants between two
transacting parties. The likelihood of a double coincidence of wants, however,
is small and makes the exchange of goods and services rather difficult. Money
effectively eliminates the double coincidence of wants problem by serving as a
medium of exchange that is accepted in all transactions, by all parties,
regardless of whether they desire each others' goods and services.
STORE
OF VALUE
. In
order to be a medium of exchange, money must hold its value over time; that is,
it must be a store of value. If money could not be stored for some period of
time and still remain valuable in exchange, it would not solve the double
coincidence of wants problem and therefore would not be adopted as a medium of
exchange. As a store of value, money is not unique; many other stores of value exist,
such as land, works of art, and even baseball cards and stamps. Money may not
even be the best store of value because it depreciates with inflation. However,
money is more liquid than
most other stores of value because as a medium of exchange, it is readily
accepted everywhere. Furthermore, money is an easily transported store of value
that is available in a number of convenient denominations.
UNIT
OF ACCOUNT.
Money also functions
as a unit of account, providing a common measure of the value of
goods and services being exchanged. Knowing the value or price of a good, in
terms of money, enables both the supplier and the purchaser of the good to make
decisions about how much of the good to supply and how much of the good to
purchase.
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