Money: Definition, Types, Functions & How It's Made Video

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  • 0:01 Why Have Money?
  • 0:47 Uses of Money
  • 2:08 Kinds of Money
  • 3:44 How to Make Money
  • 5:16 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Unfortunately for most of us, making money isn't as easy as we would like for it to be. This lesson explains the story of money, including how banks and the Federal Reserve make more whenever they want.

Why Have Money?

Imagine you were a farmer sometime in the earliest part of civilization. You notice that your neighbor, a potter, has some jars that could be very useful to your work. How do you arrange an exchange? Obviously, you could trade food for pots, but what if your neighbor already had plenty of food? What if he needed food, and you didn't want any pots?

Money has been solving problems like these for centuries, although the money we use has changed dramatically since the first coins appeared in the Iron Age more than 2,600 years ago. However, money in whatever form is still essential for any society to really prosper.

Uses of Money

It sounds almost too basic to consider, but what do we use money for? Just like the potter and the farmer, money is most frequently used as a medium of exchange. This has several advantages. For starters, money can't rot, unlike a farmer's crops. Additionally, since money is only useful as a medium of exchange, people tend not to reject it. While the potter in the above example had little use for more grain, he could always use more money. But money is useful beyond a mere exchange.

It can also be carried much more easily than bushels of grain or pallets of pots. For the ancients, this meant a rise in international trade and travel. It can be invested in order to gain ownership in a business venture. While the business ventures themselves have changed greatly, this use of money to invest goes back almost as far as coinage itself. Finally, money can act as a hedge against tragedy. If a family of rats ate the farmer's grain, he would be in an unfortunate situation. However, if he was storing only money, the rats would not have been able to consume his coins.

Kinds of Money

While many different countries issue their own currencies or money that is legal for use in a particular country or area, money actually can be classified in a much more general, and indeed useful, way. For centuries, the only money was coinage, and all of this money was commodity money. It got this name because the coin itself, whether made of gold, silver, or something else entirely, had value. Gold and silver have always been prized metals, so using them as money was an easy step.

Carrying around large amounts of money was cumbersome, to say the least. Also, it meant that a new discovery of gold or silver could flood the market with new coins. Since money is subject to the same laws of supply and demand as anything else, too much supply of money meant that the value of it plummeted. Because of this, most money around the world today is called fiat money, which has value simply because the government says that it has value and makes it illegal to refuse it.

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