Question

a) What characteristics of gold and cigarettes make them well suited to serve as a medium of exchange or limit their suitability for serving as a medium of exchange? Explain. Be specific. (7-11 sentences) b) Are gold and cigarettes commodity or fiat money? Are US dollars commodity or fiat money? Explain. (3-5 sentences)

Answer 1

a)

Earlier gold and cigarettes were used as a medium of exchange from time to time. The fact that they are widely acceptable made them to be used as a medium of exchange. However, there were some issues which made it difficult from continuing to be a medium of exchange. Cigarettes are non durable. Gold is expensive and there is a problem of portability. If you want to buy something with a lot of gold, you need to carry the entire gold all by yourself. This can be cumbersome.

There were also problems of divisibility. If something has a lower value, you might have a problem with dividing the gold or a cigarette to get the value. They were not uniform either. You can't distinguish if the gold is a genuine or fake.

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b)

Fiat money is that type of money which are backed by the government through the central bank of the country. Neither cigarettes or gold is a fiat money.

US Dollars are fiat money because they are issued by the Federal Reserve, the central bank of the country and backed by the government. That's why its also a legal tender.