Importance of money - 2

We have already considered money as commodity in the first article - importance of money.

Here we give more insight of money in more broader terms.

Money and Its Importance

Money is a thing that is usually accepted as payment for goods and services as well as for the repayment of debts.

Money originated as commodity money, but almost all contemporary money systems are based on concept of fiat money. Fiat money is of no value as a physical commodity, and derives its value by being declared by the government to be a legal tender; that is, it must be accepted as a form of payment within the boundaries of the country. This applies for "all debts, public as well as private".

The money supply of a country consists of currency and demand deposits of bank money. Currency consists of banknotes and coins and demand deposits or 'bank money' consist of balance held in checking accounts and savings accounts. These demand deposits usually account for a much larger part of the money supply as compare to currency. Bank money is intangible. It exists in the form of various bank records. Although it is intangible, bank money still carries out the basic functions of money, being generally accepted as a form of payment.

Functions of Money

Money is best defined based on the functions that it performs as "anything that is widely used for making payments and accounting"

Money is considered as -
Store of value
Common measure of value
A means of payment
Medium of exchange
Unit of account

In order to function as a store of value, money should be capable of being reliably saved, stored, as well as retrieved. It should also be predictably usable as a medium of exchange once it is retrieved. The value of money must also remain stable over a period of time.

When money is used for carrying out the exchange of goods and services, it is functioning as a medium of exchange. It thus avoids the inefficiencies of barter system, like the 'double coincidence of wants' problem.

A unit of account is nothing but a standard numerical unit of measurement of the market value of goods, services, and several other transactions. It is also known as a "measure" or "standard" of relative worth and "standard" of deferred payment. A unit of account is a necessary prerequisite for the purpose of formulation of commercial agreements which involve debt. In order to function as a 'unit of account', whatever is being used as money should necessarily be:
Divisible into number of smaller units without any loss of value

Fungible: meaning that one unit or piece should be perceived as equivalent to any other, which is why real estate, diamonds, or works of art cannot be considered as money.

A specific size, weight, or measure to be verifiably countable.
Types of Money
Commodity Money - Commodity money value is derived from the commodity out of which it is made. The commodity itself represents money, and the money is the commodity. For instance, commodities that have been used as mediums of exchange include gold, silver, copper, salt, peppercorns, rice, large stones, etc.

Representative Money - is money that includes token coins, or any other physical tokens like certificates, that can be reliably exchanged for a fixed amount/quantity of a commodity like gold or silver.

Fiat Money - Fiat money, also known as fiat currency is the money whose value is not derived from any intrinsic value or any guarantee that it can be converted into valuable commodity (like gold). Instead, it derives value only based on government order (fiat)

Commercial Bank Money - Commercial bank money or the demand deposits are claims against financial institutions which can be used for purchasing goods and services