- Money
- Money is what people regularly use when buying or selling goods and services, and so both buyers and sellers must widely accept it.
- Wealth
- Wealth is the total value of everything a person owns, from savings and shares to a house, after taking away what they owe.
The four functions of money
Can you name the four functions of money?
Each is a job money does that swapping one good directly for another does badly or not at all.
A medium of exchange acts as an intermediary between buyer and seller, so people sell goods and services for money and use the money to buy others.
Can you think of an example?
A plumber is paid £120 for fixing a boiler and spends it at the supermarket. She never has to hunt for a grocer who happens to want a boiler fixed.
A store of value holds its value over time, so money kept today will still buy goods and services tomorrow or next year.
Can you think of an example?
The plumber leaves £50 in her account for next month, and it will still buy groceries then. A stock of shoes kept in a warehouse to swap later could go out of fashion first.
A unit of account is the ruler by which values are measured, so the prices of very different things can be compared in one unit.
Can you think of an example?
The plumber charges £120 for a repair and a pair of work boots costs £60, so she can see at once that one repair is worth two pairs of boots.
A standard of deferred payment lets people buy today and pay in the future, because loans and future agreements are stated in money.
Can you think of an example?
The plumber lets a customer pay the £120 in 30 days. The debt is agreed in pounds now and settled in pounds later.
Check yourself
A shop prices a jacket at £60 and a jumper at £30, so a shopper sees at once that the jacket costs as much as two jumpers. Which function of money is at work?
Barter needs a double coincidence of wants
Without money, people barter, trading one good or service directly for another. Every trade then needs a double coincidence of wants: each person must want something the other can provide. An accountant who wants shoes has to find someone with shoes in the right size who also wants accounting done.
A pound note works only because people trust it
Commodity money, such as gold or shells, has a use besides being money. Fiat money, such as a modern pound note, has no value of its own; the government declares it legal tender, so a debt can lawfully be paid with it. Its only backing is shared trust that others will accept it.
Check yourself
A £20 note has almost no value as a piece of polymer. Why will a shop still accept it as payment for £20 of goods?
Money is the part of wealth you can spend straight away
Liquidity is how quickly an asset can be used to buy a good or service. Notes, coins and current-account balances are the most liquid assets, and they count as money. A house worth £300,000 is wealth, but it cannot pay for the weekly shop until it is sold.
Isn't a rich person just someone with lots of money?
Not in economics. Being rich usually means having a lot of wealth, and most household wealth sits in houses, pensions and shares rather than money. A farmer who owns land worth £2 million can still be short of money for this month's bills. Income is different again: a flow of pay each month.
Name the function and then show it working in the case you are given. "It is a unit of account, because the shop can price both goods in pounds and compare them" earns what "money is useful for comparing things" does not. Four functions, four names: learn them exactly.
Check yourself
Three of these count as money. Which one does not?
Exam question
A retired couple own a house worth £400,000 but have £500 in their bank account. Explain why they are wealthy but hold little money. [2]
Their wealth is the value of everything they own, including the house. Money is only the liquid part that can be spent straight away, and the house cannot be spent until it is sold.
One mark for wealth as the total value of assets owned, and one for money as the liquid part, using the house as an asset that is not money.
Money is what people regularly use to buy and sell, and it ends barter's need for a double coincidence of wants. It is a medium of exchange, a store of value, a unit of account and a standard of deferred payment. Modern money is fiat money, backed only by trust. Wealth is everything a person owns, and money is its most liquid part.