Money plays an important role in the exchange of goods and services. Prior to its introduction, people engaged in barter trade, which entailed the exchange of goods and services for other goods and services that the individual needed. One of the major challenges for such exchanges was the true value of one’s good could not be easily determined, which also led to a problem in standardizing the value of different goods and services.
Thus, the introduction of money served to address the issues brought about by previous modes of exchange. Consequently, money was developed to play three important functions, which are as follows:
Money provides a medium of exchange because it can be used to purchase goods and services instead of engaging in an actual exchange of goods, which requires some level of coincidence in finding another person willing to engage in the exchange.
Money serves as a store of value because it can be held over a long duration while still retaining its value. In this regard, it serves a similar purpose as to when people keep gold ornaments as security for future exchange.
Money provides a measure of value because one gets to know how much a good or service is worth as determined by its monetary exchange value, which may also be standardized in certain markets. In this regard, money makes it easy for people to determine the worth of a good or service.
There are generally said to be three main functions of money. All of them are important. Let us examine them.
Money serves as a medium of exchange. What this means is that you can give people money and they will give you goods or services in exchange. This is very important because it makes economic activity easy. It is much easier than if you were to have to barter in order to get the things that you need.
Money serves as a measure of value. It is easy for us to know how much something costs when we have money. We can say that a car, for example, costs $20,000. We do not have to estimate how many chickens or how many bushels of hay we would need to exchange to get a car. Everything can be valued in money.
Money serves as a store of value. What this means is that money can remain valuable over time. If you have a pig, for example, it will not hold value because it will die. Money, by contrast, tends to remain valuable over time.
These are the main functions of money. All of these functions must be fulfilled in order to have money that helps us with economic activity.