Lesson 2 of 19
Money as we know it has been around for a very long time. The currency notes and coins that we carry with us everyday are all forms of money.
In most simple terms, money can be defined as the medium of exchange. Anything that can serve as a medium of exchange can be called money.
Money has three important functions: it's a medium of exchange, it's a unit of account, and it's a store of value.
Medium of Exchange: In olden period, people used to exchange goods and services directly for other goods and services. For example, someone who had wheat could exchange it with someone else who had, say, rice. In today's context, you could exchange a burger for a movie. This is called the barter system. The money in its current form (currency notes, and coins) is called fiat money.
Unit of Account: Another important characteristic of money is that it's a unit of account. For example, if we do our calculations in terms of dollars, we know that a burger costs $2, while an ice cream costs $4. We can immediately draw the conclusion that one ice cream costs two burgers. This is the opportunity cost of buying one good over the other. However, if everyone quoted prices of their goods and services in terms of other goods and services,, life would become miserable. Having all prices listed in terms of dollars and cents makes our calculation much easier.
Store of Value: The money is also a store of value because we can store it and exchange it for goods and services at anytime. We can carry money in our pocket and confidently go anywhere and exchange it for any goods or services. However, the value of money does change over time, for example, if inflation is high, the value of money falls. So, if you have a dollar, you can buy an apple today, or you can store this dollar for a few months. Now when you go to the market to buy apples, you may get only half an apple for one dollar.
Apart from these three, money acts as a measure or qualifies as a standard for a contract involving future payments, such as loan repayments.
Since the beginning money has taken three forms:
Commodity Money: Common examples are precious metals such as gold, silver and copper. This was a common form of money in ancient times. Even in the US, gold coins were used as money till 1933. The value of the money is equal to the value of material in it, for example, 10 grams of gold.
Fiat Money: This the money declared by the government as legal tender. This is the current form of money in circulation today, i.e., notes and coins.
Fiduciary Money: A modern example is the bank deposit. In this case, the bank promises the depositor to pay an equivalent value in the form of fiat money. People can use bank deposits to make payments in the form of checks and wire transfers.