WHAT IS MONEY?
Money and Monetary Systems
• Money is everywhere in the world. All economic activity is linked
to money.
• What is Money?
• How did it develop
• What does money do?
What are the types of monetary systems?
This is what we will learn today.
Meaning of Money
Money, or money supply is anything that is accepted in payment for goods and
services or to repay debts.
Before paper money Gold or Silver was like money as we think of it.
We think of money as CURRENCY (paper money and coins)
But there are other meanings for money such as:
WEALTH - When people say, “Joe is rich – he has a a lot of money”. That can mean
he has cars, houses, a boat, stocks, bonds, other assets. Joe is wealthy.
INCOME – We might say, “Nancy has a good job and makes a lot of money” She has a
good income.
Functions of Money
• Whether money is gold or paper, it has 3 primary functions (roles
or purposes) in any economy.
• 1. A medium of exchange
• 2. Unit of account
• 3. Store of Value
• We will look at each of these seperately
1. Medium of Exchange
• In almost all market transactions (buying and selling) in our
economy, money in the form of currency is a medium (means) of
exchange; it is used to pay for goods and services.
• In the past, people used to exchange a good or service for another
good or service. This is called BARTER.
• We are going to do an activity to show you what bartering is.
Barter Activity
• There are 3 goods produced in an economy by 3
groups:
Good
Postcards
Magnet
Dice
Producer
Postcard maker
Magnet maker
Dice maker
Barter Activity Discussion
• How did you feel?
• What did you want to be able to do?
• How will introducing money into the
economy help these 3 producers?
1. Medium of Exchange continued
The time spent trying to exchange goods or services is called
TRANSACTION COST. In a barter economy, transaction costs are
high because people have to find someone who has a good or
service that they want and who also wants the good or service they
have to offer.
If we introduce money into the economy you can buy whatever you
want and it takes less time. This promotes economic efficiency. The
exchange of money is easier and quicker.
2. Unit of Account
• The second role of money is to provide a unit of account. It is
used to measure the value in the economy, just as we measure
distance in kilometers or weight in kilograms.
• By using money as a unit of account we reduce transaction costs
by reducing the number of prices. In a barter system we must
determine what each good costs so we can have an even
exchange. 100 goods may have 100 different prices. This is a
problem.
• The solution to the problem is to introduce money into the
economy and have all prices quoted in yuan or dollars.
3. Store of Value
Money also functions or works as a store of value. It can be used
anytime. You can spend what you have now or wait for another
time to spend it.
Money is not the only asset (something that has monetary value
such jewelry, houses, stocks, bonds, land, art) that can be used to
store or keep wealth. These assets can sometimes pay you more
when you sell them than what you can make with money.
3. Store of Value - Liquidity
Then why should people keep money?
The answer to this question is an important economic
term of Liquidity. Money is the most liquid asset of
all because it is the medium of exchange. Like water
(liquid) is easy to drink, money is easy to exchange, or
spend.
Evolution of the Payments System
The payments system is the method of making transactions in
the economy. This has changed over time and with it the form of
money.
Before paper money, gold was used as a means of payment.
Later, paper assets such as checks and currency began to be used
in the payment system as money. Where the payment system is
headed or going is important on how money will be defined in the
future.
Here is how the payments system has evolved or changed.
1. Commodity Money
• For anything to function as money, it must be universally acceptable;
everyone must be willing to take it in payment for goods and services.
• In the past a metal like gold or silver served as money. Money made up
of precious metals or another valuable commodity is called commodity
money. From ancient times until 200 years ago commodity money
functioned as the medium of exchange.
Discussion question
• What is the problem with paying for goods and services with commodity
money?
Commodity money discussion question
answer
Precious metals like Gold and silver are
Too heavy to carry with you.
2. Fiat Money
• Fiat money is simply the economic term for paper currency that
governments consider legal tender. This means that legally it must
be accepted as payments for debts.
• Major problems of paper currency and coins is that they are easily
stolen and can be expensive to transport in large amounts because
of their bulk. Think of the armored car and the cost to transport.
• To solve this problem the banks invented checks.
3. Checks
• A check can be written to tell your bank to transfer money from your account
to someone else’s account without the need to carry large amounts of money.
• This was a major change (innovation or new idea) that improved the efficiency
of the payments system.
• Checks reduce the transportation cost, can be written for any amount and
reduces the loss by theft or being stolen.
Discussion question?
What are the problems with payment by checks?
Checks – Answer to discussion question
1. Checks take time to get from one place
to another. If someone needs payment
today they may not get the money for 3
or 4 days.
2. Processing checks cost to much. In the
US it costs $10 billion per year to
process checks.
4. Electronic payment
• With computers and the internet it is now
cheaper to pay bills electronically.
• Paying bills can also be automatically
deducted from your account without even
the click of a mouse.
• Electronic payments are becoming far more
common in many countries.
5. E-Money
• An example of electric money or e-money is a debit
card. Debit cards are used like credit cards and are easy
to use and faster to use than cash. The money is taken
immediately out of your account.
• A more advanced form of debit card is a stored-value
card with a pre-set amount of money put on the card
paid for in advance.
• The smart card contains a computer chip that can be
loaded with cash from the owner’s bank account.
E-Finance – Are we Moving Towards a Cashless
Society? Discussion Question
Even though E-Money is easy to use and
efficient why are people reluctant or
why do people not want to use it?
What do you think? Discuss in groups of 4
Answers to E-Money Question
• First, it is very expensive to set up the computer,
card reader and telecommunications necessary to
make electronic payment work well.
• Secondly, electronic payments is a security and
privacy concern. People are afraid that someone
else might get their information and they worry
that government, employers and others might get
their data.
Summary
1. To economists, the word money, has a different meaning from
income or wealth. Money is anything that is accepted as payment
for goods and services or in paying debts.
2. Money serves 3 functions or purposes: as a medium of exchange,
as a unit of account, and as a store of value.
3. The payment system has evolved over time.
From gold or silver, to paper currency, to checks, to electronic
money.
Questions for Discussion
1. Why were people in the USA in the 19th century sometimes
willing to be paid by check rather than with gold, even though
they knew that thee was a possibility the check might bounce, or
be no good?
2. In ancient Greece, why was gold a more likely candidate for use
as money than wine was?
3. Rank the following assets from most liquid to least liquid?
a. Checking account deposits b. Houses c. Currency d. Washing
machines e. savings deposits f. Common stock