Lecture 3 What is Money? Flashcards
Economists Definition of Money?
- Not just banknotes (i.e. paper money) and coins
– this is what economists call “currency”.
• 2. Money is anything that is generally accepted in
payment for goods and services or to repay debts.
What does money do and what does it mean to society?
This means money is defined more by its function (what
goals it serves) than by its form (gold bullion, coin, paper,
binary digits, …)
• This definition of money also suggests that money is largely
a social convention
– what people in a society are generally willing to accept as money is
what constitutes money in that society
What are the Functions of Money?
Money has 3 primary functions in any economy
• According to economists, an asset can be considered
“money” if it serves three functions:
• 1. Medium of exchange
• 2. Unit of account
• 3. Store of value
What is a medium of exchange?
Money is a medium of exchange:
– it is used to pay for goods and services.
– The reason why we use it is that it promotes economic
efficiency by minimizing transaction costs (i.e. the time spent
in exchanging goods/services).
What are The criteria of medium of exchange?
• A commodity must meet some criteria to function
effectively as a medium of exchange. It must
1. be standardized (easy to determine its value)
2. be widely accepted
3. be divisible (easy to “make change”)
4. be easy to carry
5. not deteriorate quickly
Medium of exchange depends on context. Eg.
Example: cigarettes were used as money in
prisoner-of-war camps during World War II.
– Overall, they met the 5 criteria better than other available assets.
What is Unit of Account?
Money is used as a yardstick to measure the value of
goods/services in the economy
– Just like distance is measured in terms of miles/metres
If money is introduced, the prices of all goods are quoted
in terms of units of money transaction costs are minimized
What is Store of Value?
Money is a store of value:
– it is a repository of purchasing power over time.
– used to save purchasing power from the time income is received until
the time it is spent (inflation may be a problem though!)
Examples of things that have a store of value
Other assets, too, can be used as a store of value (stocks,
bonds, land, houses, etc…):
– they often generate cash flows (e.g. interest payments, dividends)
– provide some services (e.g. house)
– So, why do people hold money at all?
What is liquidity?
Liquidity refers to the ease and speed with which an asset
can be converted into a medium of exchange
What is Autarky?
Very distant past Autarky
– Every family or tribe produces exactly what they want to consume
– Output distributed across members based on social traditions
– No trade
– No money (no need for money)
What is barter?
Distant past Barter
– Trade within and between families and tribes
– Goods/services are exchanged for other goods/services
– No money
What is monetary payment system?
3) Last few millennia (as early as 9,000 BCE) Monetary
payment system
– Some societies began to use money to conduct transactions.
• Individuals and businesses trade goods/services in exchange for money.
– Money has several advantages:
• It eliminates the problem of double coincidence of wants
• It reduces the number of prices to be considered when making transactions
• It therefore reduces transaction costs
What is commodity money?
– Examples: gold, silver, copper, cattle, corn, furs, tobacco
– These were goods with an “intrinsic value”, i.e. a direct use
Disadvantages of commodity money?
– However, each type of commodity money had its own disadvantages
• E.g. gold, silver, and copper are heavy and hard to transport
• E.g. tobacco and corn are perishable
• E.g. cattle is not easily divisible
