Functions of Money

One way in which to define money is to focus on its functional characteristics — that is to say, what can it be used for in practical terms. In the before-mentioned page, Wikipedia goes on to state (emphasis ours):

Definition 2.2: The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.

The first two functions are more or less self-explanatory; the latter two less so, and somewhat interconnected. For good measure, we will provide a common sense explanation of all four. A medium of exchange is understood to mean that money can be used as an intermediary to facilitate the exchange of goods and services — i.e. it is much more efficient than bartering goods or services directly. A unit of account brings money to the realm of arithmetic; it means we can assign numeric values to goods and services, and then to use these to compute all sorts of measures related to accounting. These we shall cover in the future.

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Figure 1: Use cases for money.

A standard of deferred payment in layperson's terms just means that if you agree today to pay an amount in the future, when the day arrives, the agreed amount is expected to have more or less the same properties. If there was a collapse in belief and suddenly the money became worthless, it would not be very useful for deferred payments. Similarly, if its value oscillated too much through time, it would also make it unsuitable for deferred payments. In other words, money is expected to preserve the majority of its value over time — to act as a store of value.

Taken as a whole, these four functions make money what it is. And, as the definition stated, pretty much anything which can fulfil the functions above can be considered money. However, the different types of things used for this purposes have very different characteristics, so its worthwhile looking at them in more detail.

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