What is Money?

by James & Miel on January 7, 2008 · 0 comments

Today’s posting is on one basic financial concepts that everyone should know about. This is the idea of money. That’s right, I’m taking about greenbacks, bucks, geld, shekels, the long green, wampum – money. Everyone’s got some and most people think they know how it works and what its role is our economy.

However, according to economists money serves three major functions in our economy. These are:

1) A medium of exchange
2) A measure of value
3) A store of value

A medium of exchange: So basically, when money is used a medium of change, its a standardized way of used to pay for labor and goods. In most countries, money is in the form of paper and metallic currency or electronic check writing accounts. The key idea here is that money is a medium that’s used as change – not for any intrinsic value of coins or currency itself – its just something that you use to swap services and goods that are inherently different.

A measure of value: This essentially means that money is a standard common measuring rod by which prices, costs, revenue, etc. For example, bananas cost 25 cents, but a corporation may earn revenues of $50 million a year. Because money is standardized measure of value it lets you assign an unambiguous value to prices, costs, revenue, etc, and to determine the degree of difference between various choices.

A store of value: Money functions as a store of value in that money you received today can be saved and held for later expenditures. Right, so you get paid or earn interest and you can save it (preferable in an interest bearing account – not under the mattress) and use it for later purposes.

As a final point, I’ve often thought about how arbitrary the value of money really is. Everybody accepts dollars not because the dollar itself is valuable, dollars are simply valuable because of social and economic processes. To illustrate how arbitrary money really can be, I wanted to leave you with a few of examples of money where the social processes governing its value have gone haywire:

A 500,000,000,000 (500 billion) Yugoslav dinar banknote circa 1993.

The 100 quintillion Hungarian Pengo circa 1942.

In both these cases, hyperinflation destroyed the value of money. This suggests the final takeaway here is that money is a standardized medium of exchange and store of values that is fundamentally governed by social and economic processes – we shouldn’t take it for granted.

Best,

James

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