A-Level Economics Notes on the Functions of Money

Definitions

1. Money: A system of value that facilitates the exchange of goods and services in an economy.
2. Medium of Exchange: An intermediate tool used to enable transactions between buyers and sellers.
3. Unit of Account: A standard numerical monetary unit for measuring the market value of goods, services, and other transactions.
4. Store of Value: An asset that maintains its value over time, allowing people to save and defer consumption for the future.
5. Standard of Deferred Payment: A function of money that allows it to serve as a means for settling debts in the future.
6. Fiat Money: Money that has value because a government maintains it and people have faith in its value.
7. Commodity Money: Money that has intrinsic value, like gold or silver coins.
8. Representative Money: Money that represents a claim on a commodity, like a gold certificate.
9. Transaction Costs: The costs associated with making an exchange, which are reduced by using money as a medium of exchange.
10. Fungibility: The property of money that allows individual units to be mutually interchangeable.

Medium of Exchange

Money serves as an intermediary instrument that facilitates the buying and selling of goods and services. It replaces the barter system, making transactions more efficient.

Real-World Examples:

1. Grocery Shopping: You go to a supermarket and pick up various items. Instead of trading goods, you simply pay with money. This speeds up the transaction and makes it more convenient for both parties.
2. Online Transactions: When you buy a digital product, like an e-book, money serves as the medium that allows the transaction to occur instantly and securely.
3. Public Transport: You use money to buy a ticket or tap a card, which is much more efficient than bartering a service for a ride.

Standard of Deferred Payment

Basic Concept: Money serves as a standard of deferred payment when it allows for the settlement of debts or obligations at a future date. This function is crucial for the functioning of credit markets and long-term investments.

1. Real-World Examples:
   • Mortgages: When you take out a mortgage to buy a house, you agree to pay back the loan over a set period. Money serves as the standard that outlines your future payments.
   • Student Loans: Money facilitates deferred payments for education, allowing students to pay back their loans after completing their studies.
   • Business Loans: Companies often take loans for expansion and agree to pay them back with interest. Money standardizes these deferred payments.
2. Detailed Analysis:
   • This function is essential for economic growth as it enables long-term planning and investment.
   • It also has implications for monetary policy. For example, in a high-inflation environment, the real value of deferred payments could erode, affecting both lenders and borrowers.
   • The use of money as a standard of deferred payment minimizes transaction costs, making it the least costly way to settle future debts.

Store of Value

Basic Concept: Money serves as a store of value by maintaining its worth over time. This allows individuals and organizations to save and invest for the future.

1. Real-World Examples:
   • Savings Account: People often keep money in a savings account for future needs, trusting that it will retain its value.
   • Investments: Money can be invested in assets like stocks or real estate, which are expected to grow in value over time.
   • Retirement Funds: Money stored in retirement accounts serves as a long-term store of value, providing financial security for the future.
2. Detailed Analysis:
   • The function of money as a store of value is crucial for long-term economic planning and stability.
   • Inflation can erode money’s function as a store of value, as the purchasing power of money decreases over time.
   • Money’s ability to store value reduces transaction costs, making it a more efficient medium for exchange.

Unit of Account

Basic Concept: Money serves as a unit of account by providing a standard numerical monetary unit for measuring the market value of goods, services, and other transactions.

1. Characteristics: Money is divisible, countable, and fungible, making it an effective unit of account.
2. Real-World Examples:
   • Grocery Shopping: Prices of items are listed in monetary units, allowing consumers to compare costs and make informed decisions.
   • Stock Market: Shares are valued in monetary units, facilitating trading and investment decisions.
   • Budgeting: Households and businesses use money as a unit to plan their finances.
3. Detailed Analysis:
   • Money simplifies trade by providing a common measure, reducing the complexity found in barter systems.
   • It also lowers transaction costs by streamlining the process of valuation and exchange.
   • Government-issued money, like euros or dollars, is often the dominant unit of account.