The Four Basic Functions of Money

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  • 0:07 The Four Basic…
  • 0:39 Money Is a Unit of Account
  • 1:49 Money Is a Medium of Exchange
  • 2:27 Money Is a Store of Value
  • 3:30 Money Is a Standard of…
  • 5:12 Lesson Summary
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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

This lesson uses real-world examples to describe the four basic functions that money serves in an economy. These basic functions help to create the foundation of the money system.

The Four Basic Functions of Money

Now, let's take a look at how economists view the basic functions of money. Money serves four basic functions: it is a unit of account, it's a store of value, it is a medium of exchange and finally, it is a standard of deferred payment. Let's take a look at each one of these functions with the help of Margie the cake baker and Bob the lawn guy.

Money Is a Unit of Account

Money is a unit of account because everything in the economy is quoted in terms of it. For example, when Margie sells cakes in her bakery, she offers the cakes for sale at a certain price. That price is quoted in terms of money. Let's say she has a chocolate cake selling for ten dollars - that's a really good one, by the way. When Bob sells his lawn service, the price of his service is quoted in dollars, also. Let's say he charges $20 per yard. If you think about it, Bob's lawn service is really worth two of Margie's chocolate cakes, and Margie's $10 cake is worth a half of Bob's lawn service. Since Bob is not the only customer Margie has, and Margie isn't Bob's only customer, they need a unit of account that works for everyone in the economy. In this way, money functions as a unit of account, which is the foundation of every transaction taking place around us.

Money Is a Medium of Exchange

Money is a medium of exchange because it can be used to satisfy unlimited needs and wants. For Bob, he wants chocolate cake (who doesn't?) and lots of it. Bob is a business owner in the town of Ceelo. Every time he buys a cake from Margie's bakery, he exchanges the money he earned from his job for a cake. Money serves as an important medium of exchange in the economy, empowering people to purchase goods and services in an attempt to satisfy their unlimited needs and wants.

Money Is a Store of Value

Money is a store of value because Bob can exchange his lawn services for money one day and then use it to purchase goods and services at a later date. When he earns his paycheck, he cashes it at the bank, for example. Bob can hold on to that cash in his wallet for a few minutes, a few days or even a few months or years before he decides to exchange the money for one of Margie's outrageously, decadently delicious, chocolate cakes. Unfortunately, inflation prevents most of the money in existence today from serving as a pure store of value, because the money loses a significant portion of its purchasing power over time. However, if there were no inflation, then money would serve as a near-perfect store of value.

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