Shawn has a masters of public administration, JD, and a BA in political science.
While money has been around since ancient times, it has taken different forms. In this lesson, you'll learn about representative money, why it's useful, and why it has limitations. A short quiz follows the lesson.
What Is Representative Money?
Money is an asset in an economy that people use regularly to purchase goods and services from other people. Representative money is an item such as a token or piece of paper that has no intrinsic value but can be exchanged on demand for a commodity that does have intrinsic value, such as gold, silver, copper, and even tobacco. An item has intrinsic value if it still has value even if it is not used as money.
Throughout most of history, most money has been commodity money, which is an item used for money that has intrinsic value. Gold, copper, and silver coins are common examples. One major problem with commodity money is that it's cumbersome to use for large purchases. Just think how many silver coins you may have to use to purchase a car or a house - you would literally need a treasure chest or more. Representative money solves this problem.
How Representative Money Works
Representative money is just a piece of paper or a simple token that is easy to carry. Governments can issue the paper money in high denominations, such as $100, $1,000, and even $10,000 bills. (Yes, once upon a time, the U.S. printed $10,000 bills!) Consequently, it is much easier to carry around representative money and make large purchases. And just as important, you could go down to a bank and demand that your paper money be exchanged for its equivalent value in whatever commodity the government used. In the 20th century, you could exchange your dollar bills for their equivalent value in gold until the U.S. went off the gold standard in 1971 and transitioned to a fiat money system.
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Representative money is limited by the supply of the commodity for which it can be redeemed. In other words, the government should only issue the amount of representative money that it has the ability to convert to the commodity the money is based upon. If there is only $10 billion worth of gold in the government's vault, the government should issue only $10 billion in money. If it issues more, and enough people assert their right to convert the paper to gold, then the economy may collapse. In fact, one of the reasons most modern economies have moved from commodity money to fiat money is that there is no physical restriction on the supply of money because the value of fiat money is merely based upon government decree - it's valuable because the government says it is.
Money is an asset in an economy that people use regularly to purchase goods and services from other people. Commodity money is an item used for money that has intrinsic value. Representative money is an item such as a token or piece of paper that has no intrinsic value, but can be exchanged on demand for a commodity that does have intrinsic value.
Representative money consists of tokens or paper that have no intrinsic value; however, the holder of paper money has the right to demand that the paper money be converted to an underlying commodity upon which the value of the money is based. Representative money makes it easier to carry money and make large purchases. However, the supply of representative money should be limited to the supply of the commodity that the issuing government has to convert the paper or tokens to the commodity.
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