Money is something that we think about every day and it is a huge part of our existence, yet somehow most of us don't know the full definition of it, what all of its functions are, and why it even has so much power over us all. The full extent of what money is, all its different forms and purposes might surprise you! If you are interested in learning more about money, you've come knocking at the right door! Now, let's take a look.
Money Definition
What is the definition of money? Money is anything that can be used as a medium of exchange to make purchases. If something is given a value and accepted as a form of payment, it could be considered money. In the past, civilizations used items such as shells, beads, and bones as a form of currency. Nowadays, there are more standards surrounding money and currency.
Money is any asset or item that can be used as a medium of exchange to make purchases.
Currency is the actual paper note or coins that are used to represent money.
There are also two groups that money is split into. We call these groups M1 and M2. M1 is composed of actual currency, which is paper money and coins, and checkable deposits which are deposits made into commercial banks into either checking or savings accounts that can be withdrawn. M2 includes M1 and near-monies which are assets that are highly liquid that cannot be used as money directly but can be converted into usable money rather quickly.
Fig 1. Components of M1 and M2
Economics of Money
The economics of money, also known as monetary economics, is a branch of economics that examines the various theories behind money, and how money functions. The economics of money looks into the different types of money and how it works as a form of compensation. It also examines how monetary policy affects the economy and can be used to improve efficiency. A goal of monetary policy is to help an economy maintain stability, grow, and develop. Money is an important factor in the economy not just from an economic standpoint but also from a personal one. It is economically important because it pushes economic growth and stimulates the economy to be more productive. On a personal level, it allows society to purchase what it needs such as food, shelter, and healthcare.
To learn more about monetary policy, check out our explanation - Monetary Policy
Characteristics of Money
The characteristics of money are what give money its value. In this case, money is currency. The three main characteristics are its acceptability, its status as legal tender, and its relative scarcity. The benefit of money is that it is portable and replaces the need to carry around tradable goods such as gold, furs, or spices which are heavy and can go bad over time. Having a paper note or lighter coin that has a standardized value and is widely accepted makes trading infinitely easier. This standardized value also means that it can be easily divided into smaller units of account such as halves, quarters, fifths, and tenths.
Money: Acceptability
The acceptance of cash or checkable deposits as compensation or money is partially what gives it its value. Acceptance is the first step to legitimizing anything as money because if a government or a society does not want to accept the money as payment, this suggests that it does not hold value or at least is not in a form that is acceptable to them.
An example of acceptability would be when you are paying at the grocery store, they accept cash, credit or debit card, or food stamps. However, if you went in with the title to your car or a gold ring they would have a hard time accepting it because it is not liquid currency. No doubt both of these items hold value, but they are not accepted as currency.
Money: Legal Tender
The second characteristic of money is its use as legal tender. This is when money has been backed by a government as a legal form of payment for any personal or private debts. This adds to the credibility and acceptability of money. U.S. Dollars all have the phrase, "this note is legal tender for all debts, public and private," written on them.
Money is used all around the world for many different reasons. The uses mentioned in Table 1 are the formal uses that we learn in economics. If we want to learn about the uses of money in a more personal way we can look at how we use money in our own lives. Most people interact with money in one form or another every day. We may go to work and earn a wage. We need to go grocery shopping and buy food. Maybe, we stopped at the corner store to buy a candy bar for $1 or we borrowed $10 from a friend that we have to pay them back for today. We earn, spend, and save money nearly every day of our lives.
Money is useful for completing all of these tasks of daily life since it simplifies exchanges and interactions by being a medium of exchange when buying goods and services. It is a store of value when we drop our change into our piggy bank. It is a store of value and unit of account when we take our wages to the grocery store to buy food.
Types of Money
There are four types of money. They are fiat money, commodity money, fiduciary money, and commercial bank money. Depending on the economic and political system of a nation, the society uses the types of money that best suit their transactions.
| Types of Money | Definition |
| Fiat Money | Fiat money is entirely backed by government orders rather than a physical good. It gets its status as a medium of exchange because the government declared it an official means of payment. |
| Commodity Money | This is money that is an actual commodity that has value outside of being a medium of exchange. Commodity money can be precious metals, gemstones, spices, and even coffee. |
| Fiduciary Money | This is money that is based on trust rather than the intrinsic value of the money itself with no government backing. This form of payment relies on the trust or promise that it will be accepted as a form of payment. |
| Commercial Bank Money | This is money in the economy in the form of debt created by commercial banks. Banks loan out money based on the fiat money their customers deposited to other customers to earn interest. |
Table 2 - Types of Money
Of the different types of money, fiat money and commercial bank money are what the modern world is most familiar with since they are what are currently in use in developed nations such as the U.S. and European countries. Commodity money was often used in the past when societies were moving away from strict bartering systems and moving toward more convenient ways to engage in trade.
Example of Money
Let's take a look at an example of money. There are many different shapes and forms that money can take all around the world. Different nations use different currencies to represent their nation's wealth.
In the United States, the currency used is the United States Dollar. It comes as both paper notes and coins, the paper notes being mostly uniform in size and color but with varying designs intended to indicate the values they are representing such as $1.00, $5.00, $10.00, $50.00, or $100.00. The coins are more unique in their composition of metals and sizes such as zinc, nickel, and copper.
The United States is not the only country that uses its currency. Several countries like Ecuador, Panama, and Puerto Rico use the U.S. Dollar instead of a currency unique to them because the U.S. Dollar is stable and backed by a stronger economy which provides those nations with stability. Other nations choose to band together to share a currency to achieve a more stable economy with their common trading partners and promote collective economic growth and integration. An example of this would be the Eurozone.
The Euro Zone is a collection of 19 countries that have all collectively agreed to use the same currency: The Euro. This expedites and simplifies trade between the nations of the Eurozone which provides stability and an opportunity for economic growth. The Euro comes in denominations of €5.00, €10.00, €20.00, €50.00, €100.00, €200.00, and €500.00 (although the €500 notes are no longer issued). There are €1.00 and €2.00 coins, along with 1, 2, 5, 10, 20, and 50 cent coins.
Money - Key takeaways
- Money is any asset or item that can be used as a medium of exchange to make purchases while the currency is the actual paper note or coins that are used to represent money.
- Three characteristics that make money or currency valuable are its acceptability, its use as legal tender, and its relative scarcity.
- The main uses of money are as a medium of exchange, a unit of account, and a store of value.
- The four types of money are fiat money, commodity money, fiduciary money, and commercial bank money.
- An example of currency is the U.S. Dollar and the Euro used among the 19 countries of the Eurozone.
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