Chapter 30, Problem 1QFR

To determine

To explain:

The difference between commodity money and fiat money.

Explanation of Solution

The kind of asset that in an economy is used to purchase other people's products and services is called money. Commodity money is a commodity having an intrinsic value. Intrinsic value implies that even though it is not used as money, the commodity has utility. In the situation of financial unrest such as economic depression or hyperinflation, individuals often turn to commodity money rather than the money that their governments have permitted. The main characteristic of commodity money is that the value is directly viewed by this money's customers, who acknowledge the token's usefulness as they would acknowledge the products themselves.

Fiat money has value because it is maintained by the government and also due to the fact that two sides agree on its value in a transaction. Traditionally, the government would mint coins from precious physical commodities such as gold, silver or print money from paper which could be exchanged for a certain amount of the physical commodity. Due to the reason that fiat money is not connected to the physical resources such as national stash, it may lose its value during inflation or even become valueless if hyperinflation happens. If people end up losing confidence in the currency of a country, money won't retain its value anymore. For instance, this varies from gold backed currency; it has an intrinsic value due to its demand in jewelry making. It is also included in the production of electronic instruments and automobiles.

Economics Concept Introduction

Commodity money:

Commodity money is a currency type in where the currency's value derives from the things it is made of. At various points in history gold, silver, wheat, cattle, salt and other products have served commodity money.

Fiat money:

Fiat money is a currency issued by the government that is not supported by physical assets like gold or silver.