Chapter 13, Problem 1.1PA

To determine

Three functions of money.

Concept Introduction: Money has a major influence on the lives of most people. The more money a person makes, the more goods and services he can consume, resulting into a higher standard of living. Money is said to have three major functions in an economy, which are, medium of payment or exchange, unit of account and store of value.

Explanation of Solution

The three basic functions of money are:

1. Medium of exchange – The most important function of money is that it serves as a medium of exchange. Money commands general purchasing power to purchase goods and services which people want. Money is generally and widely accepted as medium though which most of the purchase or sales are made. When you work at a job, you expect to be paid in currency that you can readily spend on things you need such as food, gas and other goods and services. Money provides a means of exchanging goods and services throughout an economy that does not depend on bartering, making it easier to buy and sell.

2. Unit of account – The second important function of money is that it acts as a common unit of account or measure of value. Money serves as a unit of measurement in terms of which the values of all goods and services are measured and expressed. When we express the value of a commodity in terms of money, it is known as price. Placing a number on the value of a good allows goods to be more easily compared. This allows people that may not know anything about a certain good or service to immediately gauge how costly it is.

3. Store of value – Money also serves as a store of value, i.e. people can keep their wealth in the form of money. Money is perfectly liquid asset, i.e. it is ready and generally acceptable means of payment. Money allows us to store purchasing power which can be used at any time in future to purchase goods and services, including other assets. Money must maintain value over time for it to be effective. If a currency experiences rapid inflation (price levels in the economy increase) money can become an ineffective store of value, which may cause individuals to exchange money for other world currencies or stores of value such as precious metals.