Definition: Money is anything which is universally acceptable as a medium of exchange. Therefore if we can buy goods and services with it then it could be seen as money.
In ancient age, before people started to use money, barter system was used to exchange goods for one another. Barter system was useful because it allowed people to exchange what they had in excess for things which they did not have. However, there were problems of barter system. For example, how many goats would be exchanged for one cow? How many bags of rice for one bag of wheat flour?
There was also another problem, if A has rice, and wants wheat flour, B has wheat flour but wants only fish, then barter system cannot satisfy their wants, unless there is C who has fish and wants rice. So A has to go to C and exchange rice for fish and then only A can go to B to get the fish exchanged for wheat flour.
The creation of money solved this problem.
Read the story “The Goldsmith Who Became a Banker — A True Story” to get an idea of how people started using money in ancient days.
Also read A brief history of Money
Functions of money
Medium of Exchange – When money is used to intermediate the exchange of goods and services, it is performing a function as a medium of exchange. It thereby avoids the inefficiencies of a barter system. Exchange is easier and less time consuming in a money economy than in a barter economy.
Measure of Value / Unit of Account – e.g. 1 apple = MVR5, while a can of Redbull = MVR25. In a barter system (as described above), even if a double co-incidence of wants is found, there is no common unit of measure. In today’s world, each and every country has money. Therefore, determining the relative prices is very easy and quick.
Store of Value – To act as a store of value, a money must be able to be reliably saved, stored, and retrieved – and be predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain stable over time.
Standard for deferred payments – Money is also inevitably used as the unit in terms of which all future or deferred payments are stated. Future transactions can be carried on in terms of money. The loans, which are taken at present, can be repaid in money in the future. The value of the future payments is regulated by money.
Characteristics of money
Money must be durable, which means it should be usable for a long time and must be of good quality. It should not be something that gets damaged easily or spoiled in a short period of time. Since money is durable, it can be used as a store of wealth/value.
Since anything to have economic value, it must be scarce. Money is scarce and that’s why it has value. People can accept something as money only if it has value.
Money must be something that people can easily carry with them from one place to another. Today paper currency is used instead of gold and silver because paper currency is more portable.
Money must be something that everyone can accept for a unit of account and medium of exchange.
Money must be something that can measure all the goods and services accurately. For this purpose, money must be something that we can divide into small denominations.
Money must be something which has a relatively stable value over time. It should not lose its value over time. Its function as a store of value can be fulfilled only if its value is stable.
Next topic: Functions of central banks, stock exchanges, commercial banks