INTRODUCTION TO ECONOMICS 
Lesson 4  given at Alia College (Melbourne)


MONEY



Studies of human behavior suggest that money is the second most common topic of conversation. Expressions such as “money makes the world go round” and “money is the root of all evil” support the view that money is important. Even those who assert the contrary view viz that money is not important, are generally assuming that they will at least always have enough for their own purposes.

WHAT IS IT?

Like much in economics, the origins and meaning of money are a matter of dispute. A widely accepted approach is to define money as anything that fulfills the functions of money. Apart from leading us to determine what such functions are such definition highlights the fact that money can comprise any one of a number of things. 

FUNCTIONS OF MONEY

There are 3 or 4 generally accepted functions of money. They are that it acts as a 
[a] Medium of Exchange
[b] Store of Value
[c] Measure of Value or Account and Standard of Deferred Payment
The last is sometimes split into 2; a Measure of Value or Account referring more to its use in accounting relating to the present and a Standard of Deferred Payment referring more to its use in matters of credit and banking over time.

MEDIUM OF EXCHANGE

Of the 3 or 4 functions of money the primary one is that of acting as a medium of exchange. The existence of a satisfactory medium of exchange is an essential requirement for trade to exist, other than at the most basic level. This then is the basic function; the others are derivative.

BARTER

Trade is one of the distinguishing features of humankind. No dog, it is said, exchanges bones with another. The realization that both parties to an exchange of goods or services benefit was an eventuous step in the development of humanity. The direct exchange of goods and services is called barter or truck. For example, my cloth for your apples, a dentist repairing teeth in exchange for a dozen eggs. But barter was inflexible and inconvenient. You had to find somebody with something you wanted who in turn wanted what you had to offer. People soon realized that some highly and regularly desired commodities could be used to facilitate the process by acting as an intermediate good or medium of exchange. Such things could be taken in a trade even if one had no immediate use for them secure in the knowledge that one could readily on-trade them in the future. By such indirect means, people were spared the need to find direct matches for what they wanted with what they had to offer. At various times and places many commodities were used as a medium of exchange including grains, cattle, shells, tobacco [particularly cigarettes], alcohol, jewels and so forth. Eventually, over hundreds of years, the precious metals, particularly gold or silver, came to be the most widely accepted medium of exchange. Ultimately one or other or both became almost universally accepted within a particular area and in fact throughout the world. At that stage those who subscribe to the market theory of money say that money was born.

 Thereafter the money commodity ceased or largely ceased to be consumed for its previous purposes and instead was held for the purpose of money. Note that those who subscribe to the state theory of money, i.e. that money is the creation of the state, would say to the contrary; that in fact money did not arise until a government selected a metal, minted or authorized its minting into a coin of a certain weight and fineness, gave it a name and directed that it be accepted in exchange.


CHARACTERISTICS OF MONEY

From the above it is possible to deduce the necessary characteristics of money. They include;
Durable; the thing selected as money must be capable of standing up to a good deal of 
wear and tear. It can not be perishable.
Portable; it should be readily capable of being moved around and carried on the person.
Divisible; it should be capable of division into small units.
Distinctive; it should be easily distinguishable from non-money.
Consistent; one unit should be the same as another 
Convenient; it should be readily useable and transferable
Limited; supply should be limited and stable

A final characteristic is a matter of dispute. One view [the commodity money school] holds that money must have a commodity value. That is to say, that it must have a separate worth as a commodity quite apart from its value as a medium of exchange. According to this view, all money must be commodity money. Without such separate value it cannot for instance fulfill the function of acting as a store of value. Other forms of what might be referred to as money are not money at all but rather money substitutes, which cannot continue indefinitely, in, as is presently the case, the absence of commodity money. Others however insist that this is not so and that commodity money is merely a step in the evolution of money and that modern forms of fiat or government money are perfectly capable of acting as a store of value. Rather, commodity money is a relic of the past.


GRESHAM’S LAW

Named after Sir Thomas Gresham, Elizabeth 1’s Mint Master, who first enunciated it. Usually stated as “Bad money drives out good”. It operates whenever more than 1 type of money is circulating and the government attempts to fix their relationship. Thus if a country with a single metal currency e.g. gold or silver were to decree that all coins whether good or bad must be accepted at face value then the tendency would be for the good coins to be hoarded or melted down for bullion, whilst those that were debased for whatever reason would be spent or circulated.


If a country used both gold and silver coins [bimetallism] and sought to fix the exchange rate between them as for example 21 silver shillings for one golden guinea then as the relative value of the 2 metals varied over time the tendency would be for the coins of the relatively dearer metal [the good] to be hoarded or melted down whilst those of the relatively cheaper metal [the bad] would be left to circulate. 


Note that Gresham’s Law is merely part of a wider economic law which applies whenever the government attempts to decree that the value or price of things that are different should be treated as though they were fixed or the same. Thus if the government should decree that farmers should sell all their wheat or vintners all their wine, regardless of type or quality, at the same set price, then the tendency would be for them to hold back the better quality [the good] and dispose of the poorer [the bad]. . 


            David Sharp
             30 October 2001


Return to the Home Page