Money

The models so far have not included the concept of money. This is unsatisfactory because money clearly plays a part in economics. A complete macroeconomics theory must be capable of explaining the historical behavior of the price level. In addition, money may have an importance beyond the simple measure of prices, because monetary factors may influence “real” values such as output, income and employment.  Money is anything which is generally acceptable for the settlement of debts. Money does not have to be created by a central authority. In prison, cigarettes can become money simply because they are an acceptable medium of exchange. In many economies the most important source of money is commercial bank deposits. Bank deposits are money because they are generally acceptable for the settlement of debts, rather than through any legal or ‘official’ authority. ‘Legal tender’ is money which has been legally protected such that the refusal to accept it for the settlement of a debt is illegal. Even though bank deposits are not legal tender, many people find a check drawn on a bank deposit account acceptable as a form of money.  There are three forms of money: •    Coins •    Notes •    Bank deposits  Money has three functions: •    A medium of exchange: Without money, goods and services could only be traded through bartering, which is wasteful and difficult, particularly in a highly specialized modern economy. Money is used as a universally acceptable barter substitute. To be useful for this purpose, money must posess the following characteristics: -    it must be widely acceptable; -    it must have a high value to weight ratio; -    it must be divisible to settle debts of differing values; -    it must be difficult to reproduce, counterfeit or debase in value. •    A unit of account or measure of value: Money provides a standard by which the value of any good or service can be measured. If a car costs $25,000 and a hamburger costs $2, then a car is worth, and can be exchanged for, 12,500 hamburgers. •    A store of wealth: A household (or firm) can sell its factor services or goods for money, and then keep the money until it has decided what to do with it. Almost every household and firm holds some amount of money. To act as a satisfactory store of wealth, the value of money must be reasonably stable over time.