Question

What are the four main functions of money? Describe each role, and give an example of how money works and how it might not work.Why should we consider transactions costs in examining the role that money plays in society?

Answer 1

One of the definition of money which we studied in economics was " Money is what money does" this 5 worded definition talks about the main functions of money which are follows

1. Acts as a medium of exchange: One of the most basic and core function of money is that it acts as a medium of exchange. It helps in initiating the buying and selling process. And the economy today is nothing without money. for example: You visit the supermarket to buy some cheese and in return of that you make payment in the form of money.
2. Acts as a measure of valuation: Anything in this world which is of use to human beings has some value and that value is measured in terms of money. Without this measurable feature all the things that are of human use is valueless. It acts as a common measure through which exchange of goods and services takes place easily. example value of land is measured in monetary terms.
3. Can be stored easily: Since money has purchasing power potential it can be stored and used for future payments. We can store money in our bank accounts or lockers etc. Depending upon the level of inflation it's purchasing value increases and decreases accordingly. example: We can store money in the banks and collect it for retirement purposes.
4. Acts as a standard payments mechanism: The payments which we make for purchasing and making use of goods and services are all money denominated and hence money acts as a standard payment method. For example you cannot give candies to the shopkeeper in exchange of candies. This was under the barter system but now in the modern era money acts as a payment mechanism.

Okay so now talking about transaction cost. This cost plays a very important role when money is exchanged from one hand to another. The reason for the same is that many people earn by the transaction cost. for example if you were to exchange your home currency for a foreign currency say dollar then you incur some transaction cost. This cost is the cost of exchange and goes into to hand of the concerning authority. Similarly when you make online payments then also you incur some transaction cost.

Transaction cost increase the cost borne by the person for the use of some service or purchase of goods. The cost so paid is deposited in the hands of the concerned authority which is it's income. If the role of transaction costs would have ended then all the middlemen that depend upon these transaction cost would have to suffer. So the role of transaction cost plays a very important role in increasing the underlying value of money and also in moving money from one hands to another.