Forms, functions and characteristics of money

Microeconomic Decision‑Makers: Money and Banking

Objective

To understand the forms, functions and characteristics of money.

1. What is Money?

Money is any item or record that is generally accepted as a medium of exchange for goods and services, a unit of account and a store of value. It facilitates transactions in an economy and reduces the need for barter.

2. Functions of Money

• Medium of Exchange: Enables buying and selling without the need for a double coincidence of wants.
• Unit of Account: Provides a common measure for valuing goods, services and assets.
• Store of \cdot alue: Allows individuals to transfer purchasing power into the future.
• Standard of Deferred Payment: Used to settle debts and contracts over time.

3. Characteristics (Qualities) of Money

• Durability: Must withstand repeated use.
• Portability: Easy to carry and transfer.
• Divisibility: Can be divided into smaller units without losing value.
• Uniformity: Each unit is identical in appearance and value.
• Limited Supply: Scarcity helps maintain value.
• Acceptability: Widely accepted by the public and institutions.
• Stability of \cdot alue: Low inflation preserves purchasing power.

4. Forms of Money

1. Commodity Money: Items with intrinsic value (e.g., gold, silver, cattle).
2. Representative Money: Tokens that represent a claim on a commodity (e.g., gold certificates).
3. Fiat Money: Currency declared legal tender by government decree, without intrinsic value.
4. Bank Money (Deposits): Money held in bank accounts, accessed via checks, debit cards or electronic transfers.
5. Electronic Money: Digital balances used for online transactions (e.g., e‑wallets, cryptocurrencies).

5. Relationship Between Money Supply and Banking

The banking system creates money through the process of deposit multiplication. When a bank receives a deposit, it keeps a fraction as reserves and lends out the remainder. The total money created can be expressed by the money multiplier formula:

\$M = \frac{1}{r} \times B\$

where M is the total money supply, r is the reserve ratio, and B is the base money (central bank money).

6. Summary Table