Chapter 12, Problem 1E

To determine

The Various functions of money is to be determined.

Explanation of Solution

There are basically four key functions provided by money for an economy:

(1) medium of exchange,

(2) unit of account,

(3) store of value, and

(4) standard of deferred payment.

Medium of exchange states that the money is used to carry out transactions.

Unit of account is also known as a measure of value, which means that the prices are to be stated in the monetary terms.

Store of value states that the value and the fulfillment of needs and wants that can be preserved over time using the money.

Standard of deferred payment states that the payments to be made in future, such as paying off a loan, are also stated in monetary terms.

Medium of exchange:

States what we give in exchange for all that we buy is regarded as a medium of exchange.

This is regarded as the function with the help of which the term money is defined.

For example: you buy a purse in exchange for $1.

Unit of account:

The unit of account is defined as a unit in which the values are recorded, stated and settled. The basic comparison between this and the medium of exchange may seem slight, but there are certain cases where the unit of account is regarded as different from the unit in which the medium of exchange is expressed.

A few decades ago in Britain Guineas were often used as the unit of account, while the medium of exchange was expressed in Pounds. Both Guineas and Pounds in turn could be expressed in shillings -- the Pound was 20 shillings and the Guinea was 21 shillings. (British currency has since been redefined).

Store of value:

People keep in order of maintaining the value of their wealth. Again, while it would usually be regarded as same as the medium of exchange, but in the times of inflation other media might be substituted, such as land, jewelry, or collectable goods. This means that the money is "set aside" for the future use.

ex. today we are having worth 1000 dollars in actual money, but considering inflation where dollars is becoming worthless, We may try to substitute (invest) in land or jewelry on the assumption that these goods will not depreciate as bad as the "money".

Standard of deferred payment:

Is defined as the unit for stating the debt contracts. Deferred payment is defined as a payment which is to be made in the future, not in the present. Here, also it is regarded as the same to that of the exchange medium, but not every time.

During the time of inflation, people may accept the paper money for their instant payment, but insist on some other mediums, such as gold or real services and goods for the deferred payment.

For example- assuming $ is unpredictable, we come in to a contract in where there is a promise to build a house, but the time taken is for the house to build is 3 years. We enter in to a debt contract where the payment is to be made upon completion. Since it is, 3 years from present, we state in the contract that you pay me in Gold in XX troy ounce because $ at present is very unsteady.

Economics Concept Introduction

Money is defined in terms of various services or functions that it performs. One of the most basic functions is that it serves as an exchange medium, as a unit of account and as a store of value. Money's most significant function is regarded as an exchange medium which facilitates the transactions.