In ordinary conversations, people use the word money to mean wealth or income. The definition of money in economics is anything that is accepted in the payment of goods, services, or repayment of debts. Money is different from wealth or income. It is a stock concept that represents a specific amount at any given point. Money serves three primary functions in an economy: it is a store of value, a unit of account, and a medium of exchange. Of the three functions, the medium of exchange is a function that distinguishes it from assets such as bonds and stocks. Money also has its characteristics. But what are the 6 characteristics of money in economics?
Money has taken many forms throughout the history of man. Cheques, fiat, paper currency, e-money, and commodity are some of many forms or types of money that exist even today. But those forms heavily depend on how well it performs as a store of value, a unit of account, and a medium of exchange. Also, it must have several characteristics so that it can perform the three functions more efficiently. Here are the six characteristics of money in economics.
For money to perform its functions well, individuals and businesses must accept it in exchange for goods and services. In all societies, people need items they can use to buy and sell different things. It should be easier for businesses to make transactions. By accepting that “item” (commodities, fiat money, cheque, etc.), sellers can sell their goods or services, and individuals can buy what they need from sellers.
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With general acceptability as a medium of exchange, that makes trades easier and efficient. If society cannot accept money, then it will not perform its three functions. Also, it will fail to act as a standard of deferred payments. But a society can only accept money if it has value. In ancient economies, people used commodities (gold, silver, etc.) to buy and sell goods or services because they had value. It is the same way countries today accept cheques because they have a value.
For money to be a unit of account and a store of value, people must be able to divide it into smaller increments. With divisibility, it is easier to use the medium in exchange of goods or services of varying values. Also, a paper currency cannot be a medium of exchange if it is not divisible. A person must be able to use it to buy an array of different items with a range of different values.
It should be easy to divide any currency into smaller units. Dividing it means it must have increments that allow people to trade it for both aeroplanes and candy, and anything in between. Divisibility is a crucial performance characteristic of money because it will enable people to store value in things like silver, gold, and copper. Livestock is not an ideal unit of exchange because people cannot divide it into smaller units.
If money has to perform its three functions well, then it must be durable. It should retain its original form, substance, and shape over a prolonged period, or forever. Individuals and businesses only accept items as payments for goods because they have the confidence they will trade them at a later date for a different or the same good or service. Because they are durable, cheques work well as mediums of exchange. They store value from transaction to transaction.
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People use metals like copper and silver as money because they are durable. But the durability of money goes beyond the physical aspects if any currency. It also includes institutional and social durability. Consider the example of paper currencies issued by governments. Generally, paper currencies can retain their shape and form for years. However, their ability to perform the basic functions of money will depend on how durable a government is.
In all societies, it is impossible to complete an exchange if one does not have money. When a person or a business is in search of services in the market, they must bring cash along with them. In other words, the medium of exchange must be portable. Although metals perform all the functions of money, people do not always carry them around because they are somewhat heavier. But that does not mean they are not portable.
Portability is also the reason why livestock is not the ideal form of exchange. It is not easy to transport a cow from one place to another every day. Also, a cow is heavy relative to its exchange value and requires special handling. That can be inconvenient and expensive if looked from that perspective. By the beginning of the 20th century, societies accepted paper currencies because they are lighter and easy to carry around.
Money is a commodity. The more people have it, the less valuable it becomes. In other words, money only becomes valuable when it is in limited supply. When a country increases the money supply at a faster rate than the growth of its output, this causes inflation. That is because there will be more money to buy the same limited number of goods.
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Thus, an increase in monetary demand will cause businesses to increase prices of basic goods and services. But there is an exception. If the money supply in a country increases at the same pace as its output, prices will remain the same.
Money should always retain a stable value. If it is to serve its functions well, it must be worth the same value over a long period. When money loses its value all the time, people will render it as useless. That is because money is a standard for economies to measure the value of a commodity.
Through stability, it will be easier for people to exchange goods or services at reasonable prices. Also, stability ensures that money can retain its function as a store of value. In that case, it will act be a source of wealth. But if it is unstable, individuals will not invest because they know they will get a smaller or no return.
The functions that money serves interrelate with the 6 characteristics of money in economics, as mentioned above. If any of the characteristics or functions fail to work well, money loses its value. It is the same reason why people do not accept livestock as a medium of exchange because it is not portable or divisible.
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