Question

Describe each of the following economic functions of money and provide an example of each: (1) medium of exchange; (2) standard of value; and (3) store of value.

Answer 1

Money can be defined as anything which is generally accepted as a medium of exchange, measure of value, store of value and means for standard and deferred payment.

Now there are some functions of money

Medium of exchange :

Money serves as a medium of exchange, money helps to buy and sell goods. Goods are exchanged for money and this money help in buying any other good that we want. Thus money acts as an intermediary and facilitates trade. Money has removed the difficulty of double coincidence of want. Now a person A can sell his goods to another person B for money and then B can use that money to purchase anything that he wants from any other person.

Basically, by this function, the act of sale and purchase have been separated.

For eg If Steve wants a bottle of Pepsi and he also wants to sell his car then he doesn't have to wait for a person who wants to purchase his car and in exchange give him a bottle of Pepsi, he can simply purchase a bottle of Pepsi for money and he can sell his car for money. Hence money overcame the drawback of the barter system.

Standard of value

Money serves as a standard of value, it means that money serves as a measure of value in terms of a unit of account. Unit of account refers to the value of each good or service is measured in monetary terms. Measurement of value was difficult in the barter system because there was no unit of measure.

For eg If Steve gets $500 every month from his job and suppose his boss give him 4 bottles of Pepsi worth $10 each instead of his salary which is $500.

So Steve will refuse to take 4 bottles of Pepsi worth $40 instead of his salary which is $500 as he is getting lesser money.

Hence Standard of value helps in measuring goods and services in terms of money so that it becomes easy to understand goods and services on a common basis also fair transaction can be done.

Store of value

Money serves as a store of value. It means that money is an asset and can be stored for future use. Under barter system storing of value was very difficult in terms of goods, but money has completely solved this problem. Now saving can be done in terms of money, where the value of goods keeps on changing but a change in the value of money is relatively stable. Moreover, goods are perishable whereas money is not perishable, also money occupies less space for storage in comparison of goods. Hence money is the best form of store of value.

For eg If Steve wants to sell his car then he can sell his car for money and that money he can store for as much time as he wants.

In the case of barter system if Steve wants to sell his car then first he needs to figure out what he needs in exchange. Suppose he needs a bottle of Pepsi then after exchange he has a bottle of Pepsi which he cannot store for longer period of time because of its perishability as after some time Pepsi will expire.