Functions of Money: From Paper to Product

functions of money Ah, money. We love to hate it, and hate to love it. Whatever your stance on it, money is what makes the world go ’round. Why does money exist? What purpose does it serve? Where would we be if it weren’t for money? It’s hard to imagine a world where no money is exchanged, but money as we know it now hasn’t always been the main medium of exchange.

What exactly are the functions of money? Money has four main functions: it’s a medium of exchange, a unit of account, a store of value and a standard of deferred payment. What do all of these things mean? You’re about to find out!

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When you think of money, I’m sure most of you think of paper bills and small coins, whether it be the US dollar, the Czech Koruna or the Euro.

Did you know that coins used to be made of real gold and silver? The value of coins used to be so great that people would hoard them instead of buying objects that could lose their value. Since so many people began to hoard their coins instead of spending them, the United States Treasury began to print paper currency.

Nowadays, coins are made from a combination of copper and other metals, such as nickel or zinc. Needless to say, people are no longer hoarding them. On the contrary, many people pass by coins on the ground without so much as a second look!

So what exactly makes money so important? How does it help to build businesses, ruin relationships, keep us fed, and put a roof over our heads? That’s a lot of power for one little piece of paper to hold!

Medium of Exchange

Let’s say money doesn’t exist. You’re living on a farm, raising chickens, and knitting blankets. Or maybe knitting isn’t your thing, so you’re woodworking and learning to be a blacksmith. Your neighbor down the street has a couple of cows and they’re making illegal moonshine in their bathtub. One day you have a particularly rough afternoon, and all you want is a nice glass of moonshine to take the edge off. You could walk down the street and get some from your neighbor, but since money doesn’t exist, you’re going to have to barter for it. You want to take over some eggs for an equal exchange, but how many eggs are equal to one pint of moonshine? Half a dozen? Two dozen? You and your neighbor are going to have to come to an agreement, but sometimes an agreement can be difficult to come to. And what would happen if your neighbor didn’t want eggs at all?

Money provides a medium that everyone has and everyone is willing to exchange for goods. By using money as a widely accepted means of exchange, there is no need to constantly barter with others.

Unit of Account

A unit of account is basically a measure of value of a certain good or service. If a pint of moonshine was worth 3 dozen eggs, would building a porch be worth… 600 dozen eggs? It can be tricky to decide how to pay for things if there is no set measure of value. By using money as the general unit of account, suppliers of goods and services can create a set price that they are going to sell their product for. Instead of saying that a chair is worth 9 dozen eggs, 3 pints of moonshine, and 1 knitted blanket, they can simply tell the public that the chair is worth $30.

Store of Value

A store of value must be something that doesn’t lose its value over time. While currency exchanges and inflation are changing the value of money every day, it generally holds its value fairly well.

Let’s say you don’t want to use money as a store of value – you want to use hats instead. Why carry all of that cash in your wallet if you could wear its value on your head? You go to the store and purchase a hat for $15. A week later, you want to go out to dinner at your favorite restaurant. After looking at the menu for a couple of minutes, you determine that your meal will cost $15. Perfect! You have a hat that’s worth $15. You skip down to the local market and try to sell your hat. Unfortunately, since you have been wearing it for a week, it’s no longer a new product and people are only willing to give you $8. You accept the $8, head hung low, and purchase a cheaper meal.

If you had kept that cash in your wallet instead of trading it for a hat, you would have still had enough money to purchase the meal you wanted.

Standard of Deferred Payment

In simple terms, a standard of deferred payment refers to buying now and paying later. Let’s say you take out a loan for college. The amount of that loan is stated in terms of money, and your deferred payments for the future are also stated in terms of money. In order for this system of deferred payments to work, money must retain its value over time. While we’ve already learned that the value of money fluctuates over time, interest rates are put in place to even out the fluctuation. If you’re confused about interest rates or want to learn more about deferred payments, this guide to currency and debt is a great resource.

Making Smart Decisions

So now we know exactly why money is so important in society. Without it, we’d spend so much time trying to barter with others that we wouldn’t have enough time to focus on technological, medical and artistic advancements.

The first step to learning how to appreciate money is learning how to manage your money. And if you’re looking for some ways to make some extra cash, Udemy has great courses on expanding your online presence and being a successful freelancer!

The next time you cringe about spending $5 on a latte, think about how much harder it would be if you had to raise chickens for eggs to barter for that same drink!