The Functions of Money

- Article photo, courtesy of CEPR
Money is one of the most essential elements in a modern economy, designed initially as a medium of exchange and a measure of value. Over time, its role has expanded, allowing it to fulfill additional key functions. As the following couplet succinctly summarizes:
"Money is a matter functions four: A medium, a measure, a standard, a store."
These four functions—money as a medium of exchange, a measure of value, a store of value, and a standard of deferred payment—are fundamental to the smooth functioning of any economic system. This article delves into each of these functions, outlining their significance and how they contribute to economic stability and growth.
Money as a Medium of Exchange
The most important and unique function of money is its role as a medium of exchange. This function simplifies transactions between two parties by providing a universally accepted medium that can be used to exchange goods and services. In contrast to the barter system, where a double coincidence of wants is required (i.e., both parties must want what the other has to offer), money allows seamless trade.
For example, a weaver does not need to find a shoemaker who specifically wants cloth; they can sell the cloth to anyone for money and then use that money to purchase shoes. Money's wide acceptability, portability, and divisibility make it an efficient medium for exchange. It is also difficult to counterfeit and its value is often guaranteed by the government, adding to its legitimacy.
Money as a Measure of Value
Money serves as a measure of value, allowing goods and services to be priced and compared easily. This function acts as a common denominator, making it easier to evaluate the worth of various items in a standardized manner. In a world where goods and services are produced and consumed in large quantities and varieties, it would be virtually impossible to express values in terms of other goods, as in the barter system.
By providing a uniform measure, money enables the calculation of national income, company profits, and individual wealth. It also allows consumers to make informed decisions by comparing prices, facilitating better resource allocation.
Money as a Store of Value
Another critical function of money is its ability to store value. This function ensures that individuals can preserve their wealth and purchasing power over time. The need to store value arises due to the uncertainties of life, the non-instantaneous nature of production and consumption, and people’s desire to accumulate wealth.
Money allows for the storage of wealth in a form that is relatively secure and convenient. Even perishable goods, like food, can be converted into money and stored without the risk of spoiling. However, it is important to note that money's ability to store value is impacted by inflation; as prices rise, the purchasing power of stored money diminishes.
Money as a Standard of Deferred Payments
Money also serves as a standard of deferred payment, which facilitates borrowing and lending. This system allows people to borrow money today with the promise of repaying it in the future. It plays a crucial role in credit markets, enabling economic activities such as business investments, the purchase of goods and services on credit, and wage payments.
In the barter system, it was difficult to ensure that the value of a borrowed good would remain the same over time. For example, if a person borrowed a quantity of wheat, there was no way to determine if its value remained stable until it was returned. Money solves this issue because it has a more stable and widely accepted value, making deferred payments more straightforward and legally enforceable.
Conclusion
In modern economies, money performs a range of vital functions that make economic transactions more efficient, stable, and organized. Its role as a medium of exchange, measure of value, store of value, and standard of deferred payment has helped to eliminate many of the complexities that arose in earlier systems like barter. Without money, today's global economic system would be much less developed, as it provides a reliable and universally accepted method for facilitating transactions and preserving value. The functions of money ensure that economies can grow, individuals can save, and businesses can invest, all while maintaining stability and order.