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Functions of Money
The main functions of money are as a medium of exchange, a unit of account, and a store of value.
Learning Objective
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Describe the function of money
Key Points
- When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange.
- A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions.
- To act as a store of value, money must be able to be reliably saved, stored, and retrieved. In this case, the value of the money must also remain stable over time.
- Money can also function as a "standard of deferred payment", which means that its status as legal tender allows it to function for the discharge of debts.
Terms
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medium of exchange
An intermediary used in trade to avoid the inconveniences of a pure barter system, such as money.
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unit of account
a standard monetary unit of measurement of value/cost of goods, services, or assets.
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store of value
An asset such as money or gold that is purchased or accepted as payment for goods and services for its ability to purchase other assets in the future without rapidly losing its purchasing power.
Example
- After World War II, at the Bretton Woods Conference, most countries adopted fiat currencies that were fixed to the U.S. dollar. The U.S. dollar was in turn fixed to gold. In 1971, the U.S. government suspended the convertibility of the U.S. dollar to gold.
Full Text
Money acts as a standard measure and common denomination of trade. It is thus a basis for the quoting and bargaining of prices. It is necessary for developing efficient accounting systems, but its most important use is that it provides a method to compare the values of dissimilar objects. Money is generally considered to function as:
- A medium of exchange
- A unit of account
- A store of value
A Medium of Exchange
When money is used to intermediate the exchange of goods and services, it is performing the function of a medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the dependence on the occurrence of a coincidence of wants. To be widely acceptable, a medium of exchange should have stable purchasing power. It should therefore possess the following characteristics:
- Valuation of common assets
- Constant utility
- Low cost of preservation
- Transportability
- Divisibility
- High market value in relation to volume and weight
- Recognizability
- Resistance to counterfeiting
Gold was long popular as a medium of exchange and store of value because it was inert and was convenient to move because even small amounts of it had considerable value. Gold also had a constant value due to its special physical and chemical properties, which made it cherished by men.
A Unit of Account
A unit of account is a standard numerical unit of measurement of the market value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial agreements. To function as a unit of account, whatever is being used as money must meet these characteristics:
- It must be divisible into smaller units without loss of value. For example, precious metals can be coined from bars, or melted down into bars again.
- It must be fungible. In other words, one unit or piece must be perceived as equivalent to any other. This is why diamonds, works of art, or real estate are not suitable as money.
- It must have a specific weight, measure, or size in order to be verifiably countable. For instance, coins are often milled with a reeded edge, so that any removal of material from the coin (lowering its commodity value) will be easy to detect.
A Store of Value
To act as a store of value, money must be able to be reliably saved, stored, and retrieved. Moreover, it must be predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain stable over time. Put simply, money acting as a store of value allows its owner to transfer real purchasing power from the present to the future. Some have argued that inflation, by reducing the value of money, diminishes its ability to function as a store of value. Money can also function as a "standard of deferred payment", which means that its status as legal tender allows it to function for the discharge of debts.
Functions Of Money
Money, such as the US Dollar, functions as a medium of exchange, a unit of account, and a store of value.
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Key Term Reference
- Assets
- Appears in these related concepts: Defining Long-Lived Assets, Defining the Marketing Objectives, and Secured vs. Unsecured Funding
- Market
- Appears in these related concepts: A Brief Definition, Targeting Consumers Where They Spend Time, and Addressing Market Needs
- Purchasing
- Appears in these related concepts: Open Market Operations, The Sales Process, and Purchasing
- accounting
- Appears in these related concepts: Managing to Prevent Fraud, Specific Identification Method, and Flow of Inventory Costs
- asset
- Appears in these related concepts: Introduction to the Balance Sheet, Limited-Life Impairment, and Activity Ratios
- barter
- Appears in these related concepts: Countertrade, Marketing Data Types, and The Functions of Money
- currency
- Appears in these related concepts: Maintaining a Strong Economy, Non-Bank Financial Institutions, and Example Transactions Showing How a Bank Can Create Money
- debt
- Appears in these related concepts: Debt Utilization Ratios, Deficit Spending, the Public Debt, and Policy Making, and Collection from Delinquent Payables
- developing
- Appears in these related concepts: The State of Global Business, The State of Technology, and The World Bank
- good
- Appears in these related concepts: A Brief Definition of Business Ethics, Vending Machines, and The Benefits of a Good Brand
- inflation
- Appears in these related concepts: FIFO Method, Macroeconomics, and Long-Run Implications of Fiscal Policy
- loss
- Appears in these related concepts: Partnerships and Taxes, Cost-Based Pricing, and Types of Partnerships
- media
- Appears in these related concepts: The Media, Creating a Media Plan, and Media Types and Scheduling
- money
- Appears in these related concepts: Assets, Measuring the Money Supply, and The Economy
- price
- Appears in these related concepts: Product, Placement, Promotion, and Price, Break-Even Analysis, and Defining a Market System
- purchasing power
- Appears in these related concepts: Defining and Measuring Poverty, Measuring Inflation, and The Costs of Inflation
- services
- Appears in these related concepts: Outsourcing, Service Economy Growth, and Terminology of Accounting
- standard
- Appears in these related concepts: Technological Barriers, Standard Units (SI Units), and Controlling Activities
- system
- Appears in these related concepts: Exact Numbers, Definition of Management, and Comparison of Enthalpy to Internal Energy
- value
- Appears in these related concepts: The Meaning of Price, Basic Color Vocabulary, and Gouache
- values
- Appears in these related concepts: Influenced by Overall Culture, Defining Values, and Defining Ethics
Sources
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Cite This Source
Source: Boundless. “Functions of Money.” Boundless Business. Boundless, 21 Jul. 2015. Retrieved 18 Oct. 2015 from https://www.boundless.com/business/textbooks/boundless-business-textbook/the-functions-of-money-and-banking-21/money-as-a-tool-123/functions-of-money-568-3194/