What is money?

1 Answer
Aug 11, 2015

Economists generally assert three functions of money: 1) medium of exchange, 2) unit of account, 3) store of value.


Medium of Exchange refers to the most obvious function of money -- we can use it in buying or selling goods and services. Note that we do not always need to use money. We could use goats or chickens or many other things in a barter economy. Barter economies often become terribly inconvenient. I don't want to take a bunch of goats to the grocery store or to the gas station to exchange for what I want.

Unit of Account refers to how we measure the value of -- well, almost everything. My favorite example is the balance sheet of a corporation, which has many assets and liabilities. Just consider the assets -- buildings, equipment, supplies, etc. We could list the assets of one corporation, but when we compare one corporation to another, we want a standard of value so that we know which corporation is larger, perhaps. So, we measure buildings not in square feet and supplies not in tons but all in dollars or in some other currency -- the unit of account.

Store of Value refers to the ability of money to hold its purchasing power (see Medium of Exchange) over time. In the short run, under normal circumstances, this may seem trivial. In a high-inflation environment, money fails to provide this function. In situations of very high inflation, we see that individuals do not prefer to use money. Wealthy people will buy gold as a hedge against inflation. People will try to hold other currencies if the currency of their own nation is not functioning well as a store of value. People will sometimes revert to barter exchange, as well.

Central banks also have some technical definitions of money, related to different forms of assets with differing levels of "liquidity". Discussion would require a separate answer to the question.