Money is a widely used medium of exchange. It facilitates trade and gives people a way to store wealth.
What Is Money?
There has always been some sort of medium that people in communities used to exchange goods and services. That medium is called money, and it has three main functions:
Store of Value: When you work for an hour, you expect to be paid in a currency (money) that will still have value when you go to spend it on food or rent. If the value of the currency changes too much or too quickly, people stop trusting it and look for other ways to exchange goods and services (like through bartering).
Medium of Exchange: Money makes trade efficient. Imagine trying to buy groceries without any kind of common unit of exchange. You’d have to find someone selling food who also happened to want whatever you had to offer … not very efficient!
Unit of Account: Money serves as a unit of measurement for valuing goods and services.
Types of Money
There are multiple types of money. Here’s a look at the different types and their characteristics:
Cash is a type of currency that’s issued by a government or central bank. The government uses it to buy goods and services from the public and pay for its operations. You can also use it to buy goods and services directly from other people if they agree to accept your cash in exchange for what they’re selling.
Cash money can be in the form of coins, paper bills, and demand deposits that are held at financial institutions in different types of accounts. Demand deposits are also known as mobile money because they can be transferred easily with a phone call or an electronic transfer order.
Commodity money is any item that is widely accepted as a means of exchange. You may have heard the term “bartering” used to describe two people exchanging goods for items rather than using cash. Historically, gold and silver were used as commodity money (think of coins), but in modern times, cigarettes and alcohol have also been used.
Fiat money is any currency issued by a government and deemed legal tender. The key difference between fiat money and commodity money like gold or silver is that fiat money is not backed by any physical object — it has value only because a government maintains its value, or because two parties in exchange agree on its value.
Representative money is any form of currency that represents something else of value — in other words, there’s an asset backing it up. For example, paper currency used to be redeemable for gold or silver — today, it’s just paper with no intrinsic value other than what we’ve agreed is its worth. Many currencies today are representative money, in that they’re backed by the assets held by the issuing country’s central bank.