What Is Money?
What Is Money?
By The Investopedia Team Updated June 22, 2021 Reviewed By Robert C. Kelly
Money makes the world go around. Economies rely on the exchange of money for products and services. Economists define money, where it comes from, and what it's worth. Here are the multifaceted characteristics of money.
KEY TAKEAWAYS
*Money is a medium of exchange; it allows people to obtain what they need to live.
*Bartering was one way that people exchanged goods for other goods before money was created.
*Like gold and other precious metals, money has worth because for most people it represents something valuable.
*Fiat money is government-issued currency that is not backed by a physical commodity but by the stability of the issuing government.
*Above all, a money is a unit of account - a socially accepted standard unit with which things are priced.
Medium of Exchange
Before the development of a medium of exchange—that is, money—people would barter to obtain the goods and services they needed. Two individuals, each possessing some goods the other wanted, would enter into an agreement to trade.
Early forms of bartering, however, do not provide the transferability and divisibility that makes trading efficient. For instance, if someone has cows but needs bananas, they must find someone who not only has bananas but also the desire for meat. What if that individual finds someone who has the need for meat but no bananas and can only offer potatoes? To get meat, that person must find someone who has bananas and wants potatoes, and so on.
The lack of transferability of bartering for goods is tiring, confusing, and inefficient. But that is not where the problems end; even if the person finds someone with whom to trade meat for bananas, they may not consider a bunch of bananas to be worth a whole cow. Such a trade requires coming to an agreement and devising a way to determine how many bananas are worth certain parts of the cow.
Commodity money solved these problems. Commodity money is a type of good that functions as currency. In the 17th and early 18th centuries, for example, American colonists used beaver pelts and dried corn in transactions.1 Possessing generally accepted values, these commodities were used to buy and sell other things. The commodities used for trade had certain characteristics: they were widely desired and, therefore, valuable, but they were also durable, portable, and easily stored.
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