DOES INFLATION,WHICH IS AN INCREASE IN THE PRICE LEVEL, AFFECT THE THREE FUNCTIONS OF MONEY? IF SO,HOW.
The three functions of money in books that I have used in my classes are
- Medium of exchange
- Store of value
- Unit of account
Of these, the only one that is likely to be seriously affected is the second one -- money as a store of value.
If you have saved money, you hope it will be worth at least as much in the future as it is now. However, if there is inflation, your money loses its value. If you saved $100 in 1970, the year I was born (and you just kept it under your mattress gathering no interest), it would only be worth $17.21 in today's money, according to my favorite online inflation calculator.
So where there is inflation, your money does not hold its value.
Money is anything that serves as a commonly accepted medium of exchange.
The central function of money is as a medium of exchange. We exchange goods and services in return for money. This is an alternative to the system of bartering goods and services we have for other goods we want. The biggest advantage of use of money for exchange rather than bartering is that it is not necessary for a person in need for a good or service to exchange it with some one who necessarily needs some other goods or service available with the person.
The second important function of money is a unit of account. It is the unit for measuring the value of things.This makes it possible to compare value of diverse goods and services.
Money is also used as a store of value.
Inflation affects these these functions differently. Inflation makes no difference in its use as a medium of exchange. But when the changes in prices due to inflation is different for different goods and commodities, their relative values change. Finally the inflation reduces the value represented by store of money.