Covering this topic last week at a revision course and there was some confusion between the functions of money and characteristics. It is important to remember that the characteristics fall within the medium of exchange. Below are some notes and a video about how hyperinflation impacts people in Venezuela and the functions of money.
1. Medium of exchange. This is very important in a specialised economy as barter would be very inefficient. It also makes possible a great extension of the principle of specialisation.
The desirable qualities of money are as follows:-
- Acceptable: Must be sure somebody will accept your money for goods & services
- Scarce: Should be, if there’s too much, then no one would value it, hence gold was always good money.
- Portable: Convenient to carry around
- Divisible: Can be divide up into different denominations
- Durable: Money (physical) that can last
2. Unit of Account. A unit of account is a way of placing a specific value on economic goods and services. Thus, as a unit of account, the monetary unit is used to measure the value of goods and services relative to other goods and services. It thus enables individuals to compare, easily, the relative value of goods and services. A firm uses money prices to calculate profits and losses: and a typical household budgets its regular expenses daily using money prices as its unit of account.
3. Store of Value. Once a commodity becomes universally acceptable in exchange for goods and services, it is possible to store wealth by holding a stock of this commodity. It is a great convenience to hold wealth in the form of money. Consider the problems holding wealth in the form of wheat. It may deteriorate, it is costly to store, must be insured, and there will be significant handling costs in accumulating and distributing it.
4. Standard of Value/Standard of Deferred Payment. An important function of money in the modern world, where so much business is conducted on the basis of credit, is to serve as a means of deferred payment. When goods are supplied on credit, the buyer has immediate use of them but does not have to make an immediate payment. The goods can be paid for three, or perhaps six, months after delivery.
How does hyperinflation affect the functions of money?
Medium of exchange – consumers may lose confidence in this function of money and therefore resort to barter.
Store of value – inflation erodes the value of money so does not keep its value. Better for consumers to spend their money rather than see it decline in value. Also they can’t afford to save.
Unit of account – prices change with inflation making comparisons difficult. Also notes need to be printed in higher denominations.
Means of deferred payment – with inflation decreasing the value of money the amount of money that you pay back to the lender decreases in real terms. However the lender is most likely to increase the cost of borrowing so they are protecting the value of money owed to them.