MAB - Money, Money, Money, Money Lesson

Money, Money, Money, Money!

Imagine: You live in a small town in the American West in the year 1834. Read the conversation below on barter among your friends Joe, Lucy, and Sally.

SALLY: Wow, Joe! You caught a lot of our fish! Want to trade for some of these fresh eggs I have? JOE: I have more than I can eat, but I don't need eggs - I need cornmeal to batter the fish. SALLY: Lucy ground some cornmeal just the other day. I wonder if she needs eggs. Here she comes. I'll ask her. Lucy would you like to trade some of your cornmeal for my eggs. LUCY: Sorry I don't need eggs. I need firewood. Jack has some, but he doesn't need meal. He could use eggs though. SALLY: So I'll trade the eggs to Jack for firewood, trade the firewood to Lucy for cornmeal, then trade the cornmeal to you, Joe, for fish!

Your friends are using barter to get what they need. To barter is to exchange goods without money. Kind of complicated, isn't it? How do they know how many eggs to trade for the firewood? How fresh are the fish and the eggs? Does it matter? What could have made the whole transaction easier?  

When you want eggs or fish, you use currency or money to buy them. You do it because:

  • Money is a medium of exchange
  • Money is a store of value
  • Money is a unit of account

As a medium of exchange, money is widely accepted as a method of payment. When you stop at the convenience store, you have confidence that the clerk will accept your money as payment for the things you wish to purchase..

As a store of value, money is something I can trust to keep its value over time. If my grandmother gives me $50 for a birthday present (Thanks, Grandma!), I don't have to run out and spend it right away. I can trust that it will still have a value of $50 tomorrow, a week from now, and a year from now. Money is a strong store of value but not a perfect one. Inflation will diminish its buying power over time.

As a unit of account, money helps us measure economic transactions as a common measure of value. Without money and using barter, it would be very difficult to measure the economic value of anything. How many bushels of corn, after all, does it take to buy a cow. Using money however, we can easily see the relationship between the price of a bushel of corn and the price of a cow.

Three Types of Money

Money comes in three types:

Commodity Money has value because the substance it is made of has value. Representative Money: This type of money represents and is backed by a commodity. Fiat money: This money is money because the government says it is.

- Commodity Money - This is money that has value because the substance it is made of has value. Some examples are gold and silver. Gold and silver are valuable because they have other uses than just serving as money.

- Representative Money - This type of money represents and is backed by a commodity. That means you can swap it for the commodity. Half a century ago, U.S. money was on the gold standard and our paper money could be exchanged for gold. During the Great Depression, PresidentFranklin Roosevelt took the U.S. off the gold standard, a move which helped the U.S. economic recovery. Again in 1971, President Richard Nixon refused to allow the U.S. to continue to swap paper money for gold as foreigners with lots of cash were putting big demands on the U.S. gold supplies. This removed the U.S. from the gold standard once and for all.

- Fiat Money - This money has no intrinsic value and does not represent another valuable commodity in a vault somewhere. This money is money because the government says it is. A note on all of our currency reads "This note is legal tender for all debts, public and private." Thus, our money is good by government decree.

Characteristics of Money

We have reviewed the functions and the types of money, but what are the characteristics that make something useful as money? Let's take a look:

- Durability - Money should be able to stand up to some wear and tear. It should be hard to destroy it. It should also be easy to replace if it gets worn or damaged.

- Portability - You need to be able to carry it around easily. Our paper currency and coins do this well. Much easier to carry around than a cow!

- Divisibility - It should be easy to divide the money. Our currency and coins are designed in denominations that make dividing them easy.

- Uniformity - When we think about our currency, it is easy for us to identify a $20 bill, or a $5, or a $100. All of our currency looks similar and its uniformity is part of what makes it portable also.

- Limited Supply - Governments and central banks work feverishly to maintain balance in a country's money supply. Money has to have a limit to its supply or it can become worthless.

- Acceptability - Because our government recognizes our money, protects its supply and we believe in it, our currency and coins are acceptable not just in our country but also in others.

Self Assessment

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