1.1.5 - Functions of money (Part of specialisation and division of labour)

Question 1

Define money

Answer 1

any item such as a coin or bank balance, which serves ALL of these functions:

. a medium of exchange

. a measure of value

. store of value

. method of deferred payment

Question 2

Define Barter

Answer 2

Swapping one good for another good without the use of money

e.g. dozen eggs for milk

Question 3

Disadvantages of Barter economy

Answer 3

. It requires a ‘double coincidence of wants’

. Doesn’t allow you to easily enter into future contract for the purchase of many goods and services. This leads to another disadvantage; it’s time consuming to barter

e.g. for perishable good it may be difficult to exchange them for goods in the future. Imagine a farmer wanting to buy a tractor in six months using a fresh crop of strawberries harvested today. Because the strawberries won’t last, such a transaction is unlikely to occur

Both of these disadvantages limits economic growth

Question 4

Explain ‘double coincidence of wants’

Answer 4

.What one person wants to buy is exactly what the other person wants to sell. This is harder than it sounds.

E.g. A person wants to buy shoes. The person doesn’t just need to find someone who has a pair of shoes in the correct size to sell, but they have to find a person who is also willing to exchange the shoes what the account has to offer

Question 5

When bartering often take place?

Answer 5

Often occurs in economies, where individuals or small groups are self-reliant and the need for trade is small

Question 6

Explain measure of value

Answer 6

Money acts as a unit of account

e.g. if a banana costs 50p and an egg costs 25p, then value of one banana is equal to the value of two apples

. At times of VERY HIGH inflation (hyperinflation), money ceases to act as a unit of account as prices may change by the hour

Question 7

Explain store of value

Answer 7

. Store of value is anything that holds value. Since it is a store a value, it gives incentive for people to either sell goods and save money

. Refers to how ‘ Money acts as a link between the present and the future unless high inflation destroys this link’

Question 8

Explain Deferred payment

Answer 8

. Money allows for borrowing and lending. People can therefore pay for things without having money in the present and instead pay for it in the future

. This relies on money storing its value

. Means that if money is usable to make purchases, it must also be acceptable for contracts signed today that will be paid back in the future

Question 9

Explain Medium of exchange

Answer 9

. Arguably most important function

. Money is used to buy and sell goods and services. A person accepts money, because she knows that she will be able to use that money to buy products in shops

Question 10

Name the five forms of money

Answer 10

. Cash

. Money in current account

. Near monies

. Non - financial assets

. Money subsitutes

Question 11

Explain Cash

Answer 11

. Cash means notes and coins.

. Has no intrinsic value (unlike gold)

. Issued by government

Question 12

Define Intrinsic value

Answer 12

Measure of what an asset is worth

Question 13

Name the three functions of money that are affected by inflation

Answer 13

. Measure of value

. Store of value

. Method of deferred payment

Question 14

Explain money in current accounts

Answer 14

. Banks in the UK offer customers current account facilities

. Current accounts have two features:

1.) Cash can be withdrawn on demand from the account if its in credit

2,) Account holders are provided a cheque book and debit cards to purchase goods and services.

Question 15

Disadvantages of money in current account

Answer 15

. Little to none interest is offered on account so current account deposits lose value over time due to inflation. Although this disadvantage is also the same for cash

. Not all people and firms accept cheques and debit cards in transaction

Question 16

Explain Near Monies

Answer 16

. Assets but only fulfils some of the functions of money: measures of value and stores of value

. They can’t be used as mediums of exchange

. However, they are easily convertible into a medium of exchange quickly at little cost so they have a high liquidity

. Most common type of near monies are time deposits with banks

Question 17

Define Liquidity

Answer 17

The ease at which an asset can be converted into money without loss of money

The more liquid an asset, the more easily it is convertible into money.

Question 18

Define monies

Answer 18

Plural form of money

Question 19

Most common near monies

Answer 19

Time deposits

Question 20

Explain Time deposits

Answer 20

. Done through banks and building societies

. Pays higher rates of interest than current accounts. They are used more for savings and less for making transactions than current

. It’s called a ‘time’ deposit, since depositors need to give notice if they wish withdraw from the account

. Some accounts offer instant access if an interest rate penalty is paid (i.e. the saver loses money for the privilege of instant withdrawal.)

Question 21

Explain non - money financial assets

Answer 21

. All financial assets can be converted into money

. There’s some disadvantages of non-money financial assets: There can be long waiting times for withdrawals; there can be considerable loss of money from conversion

. These disadvantages impairs their functions as measures of value and stores of value, therefore non-money financial assets are not classified as money.

E.g. Shares are easily sold, but it could take up to a month to receive the money. Shares also change rapidly in value so it is a poor store of value (when share price falls) or poor method of deferred payment (when share prices rise when you’re wanting to purchase) .

Question 22

Examples of financial assets

Answer 22

. Cash

. Stocks

. Bonds

. Bank deposits

. Loans

. etc.

Question 23

Example of non - money financial assets

Answer 23

. real estate

. vehicle

Question 24

Explain Money substitutes

Answer 24

. anything which can be used as a medium of exchange but not stores of value

. Includes charge cards and credit cards

. There are not stores of value as possession of a card doesn’t show that the cardholder has money in the card account

. The card only represents an ability to borrow money instantly.