Wednesday, December 17, 2014

Three Roles of Money

Money has three roles.
The first role of money is to be a medium of exchange. People have needs and wants that they cannot produce themselves. They also have skills so that they can provide services and create goods in excess of what they need. This surplus is what they create to trade on the open market. Without money, a chicken farmer who wants a massage has to carry around his chickens to the massage place to trade for a massage. The problem is that the farmer also had to find a masseuse that wanted a chicken in exchange for his services. Money as a medium of exchange got rid of this so that there is something standing in as chickens and massages that are more universally accepted in trade. Ideally, this chit is portable, durable, and not easily copied. It mediates trade and makes markets more efficient (Krugman & Wells p. 413).
The second role of money is as a store of value. In the previous example, the chickens have value for a time, but they will eventually die or be consumed for dinner. Money as a store of value is something unlike the chickens in that it will not perish and instead will maintain purchasing power in the future. It is just as tradable now as it is the future.  Krugman (2013) notes that this is not a unique feature of money, as many things can hold their value over time and not perish (p. 414). Land, is a good example of such a good
The final role of money is as a unit of account. The unit of account role of money allows for easier comparisons and allows people in the marketplace to quantify the value of goods and services in trade. As in the masseuse and the farmer example, instead of one chicken in exchange for one massage, it allows for more specifics (Krugman & Wells p. 414). How big is the bird? How old is it? How long is the massage expected to be. All of these are points of negotiation that do not need to happen when there is quantification. Units give clarity in conversation and negotiation so that all parties are speaking of similar things.

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers