Macroeconomics

An Introduction to Money

These notes focus on the definition and functions of money. Understanding what money is and what it does is a prerequisite for further understanding of this area of economics which is known as monetary economics.

What is money?
Money is any asset that is acceptable as payment in transactions and in settlement of debt. But there is a difference between money and legal tender. It is possible for some things to act as money without being legal tender. E.g. foreign currencies such as the dollar and euro can act as money in the UK but are not legal tender. Legal tender is defined as money that a creditor must be prepared to accept in settlement of a debt. Bank of England bank notes are legal tender in England and Wales and so are coins (up to a certain limit) produced by the Royal Mint and issued through the banking system. Creditors cannot refuse to accept payment in the form of legal tender but do have the right to refuse payment which is not legal tender.

Characteristics of money
Money must be: Acceptable - users must have confidence that it will be recognised and accepted as money. Acceptability is the most important characteristic of money unless it is acceptable it cannot fulfil the functions of money. Recognisable- easily identifiable. Scarce - to be scarce its supply should remain less than its demand. Essentially its supply must be controlled in some way. Difficult to forge- so that people cannot make their own money Stable the conditions of its supply and demand should remain stable so that its value remains stable. Homogeneous - each of its units should be exactly the same as every other unit. Durable it should be long lasting and should not be a wasting asset.

Portable -easy to carry. Divisible it should be capable of dividing into small units without loss of value

Functions of money
Money is defined by its functions which are: 1. Medium of exchange 2. Store of value 3. Unit of account 4. Standard of deferred payment. In other words, money is anything that fulfils the functions of money. Medium of exchange Money allows people to buy things without the use of barter. People are willing to exchange their goods and services for money Money should act as wealth with liquid purchasing power, giving its possessor the freedom of choice in the satisfaction of wants. Store of value Money allows: -people to save. -individuals to forgo consumption in the current time period and to save to increase spending power in the future. -wealth to be stored up indefinitely without deterioration in value. It can then be exchanged, now and in the future, without loss in purchasing power, for other goods. People are willing to hold on to money because it generally keeps its value( although not with inflation). Controlling inflation is a requirement for money to function as a store of value. Unit of account People can measure the value of things in money. The price of goods is expressed in terms of money. As a unit of account money enables:

-accounts to be kept. -costs to be assessed precisely. -choices to be made. -relative prices to be compared. Standard of deferred payment People are willing to accept money as payment in the future. Therefore money -allows payments to be put off until later. -allows payment for goods and services consumed today at a future time period. -enables contracts to be fulfilled in the future to be assessed now, thereby equating present and future values.