Topic 1: Purposes of Money Flashcards
What is money?
Anything that is widely accepted as a means of making payments: coins, notes, and electronic balances held in bank accounts
Purposes of money:
- Main purpose: to make payments
- To set the price of goods
- To be stored to make purchases in the future
- To buy items now
- To be borrowed to make purchases now, and repay the lender in the future
What is bartering?
Before money was created, people used a bartering system to trade goods or services
What are the limitations of bartering?
- It relies on a ‘double coincidence of wants’ (both people need to want something that the other person has)
- It relies on the two parties agreeing a rate of exchange - which can be time consuming
- It relies on each party having a surplus of the what they already have, to trade it for something else
What is an intrinsic value?
A valued item to all people in a community, that was used as a means of payment e.g. rice in Japan. Intrinsic values came about due to the limitations of bartering
Valuable items used as intrinsic values include:
- Cowrie shells
- Pigs
- Feathers
- Stones
- Leather
- Salt
- Oxen
- Vodka
- Metals (e.g. gold) - these could be used to make weapons, tools and or jewellery
Drawbacks of intrinsic values:
- Some of the items were not durable (e.g. cattle and pigs die, grain can perish if not stored correctly)
- Some items cannot be divided into small amounts to make low value purchases, or give change
- Many early forms of money were not portable
- Some intrinsic values had values of their own, which could vary (like gold - e.g. when there was a lot of gold, an ounce of it could be worth 2 cows, but when it was scarce, one ounce of gold could be worth 4 cows)
Using items that represent intrinsic values as money:
An example of this is in China, where spades and knives had been used as intrinsic values for bartering, but later coins were developed in the shapes of small spades and knives, to represent a standard value where each coin was worth roughly the same as the real spade or knife. The coins were often made from a cheap metal with little value themselves (bronze or copper), but instead representational value
Using paper notes as money:
China developed the idea of paper banknotes around seventh century CE. Merchants who traded high-value goods found it impractical to carry large quantities of copper coin. Instead they deposited the coins with a trusted person, who gave them written receipts stating how much was stored in their name. Rather than paying for goods with the actual coins, merchants paid by passing the receipt for the coins to the person selling the goods, who could claim the coins in storage. Over time, people no longer claimed the coins from storage because buyers and sellers agreed that the banknote represented the value of the coins and would accept the banknote as payment, knowing they could use it to make payments of their own
Modern payments:
Most purchases are now made using coins and banknotes or by transferring electronic balances between bank accounts. However, barter systems still exist in some communities, especially those where the people have little or no cash. Some barter systems are informal, with friends and neighbours trading skills such as gardening and cake-baking or baby-sitting. There are also bartering websites that help put people with a ‘coincidence of wants’ in contact. More formal systems exist, too, such as local exchange trading systems or schemes (LETS), which operate on a system of credits without the need for cash. Another variation on the local theme is alternative currencies
In order to fulfil its purpose, money must be:
- Acceptable
- Recognisable
- Stable
- Divisible
- Durable
- Portable
- Scarce but sufficient
- Homogeneous
Features of money: acceptable
People are only willing to accept money as payment for goods and services if they are confident that others will, in turn, accept money from them as payment in later transactions. We have seen that coins, banknotes and balances in bank accounts al represent value rather than having an intrinsic value of their own. This means that people have to trust that they will be accepted
Part of the reason why people are prepared to accept money is because they have faith that coins and banknotes are worth their face value, that is, the denomination written on them - a promise signed by the Chief Cashier of the Bank of England. This is why money is said to have a ‘fiduciary value’ - which is based on trust in the banking system
Features of money: recognisable
Cash must be recognisable so that people are confident they receiving genuine coins and banknotes (e.g. in the UK a 20p coin has seven sides, so someone was given a round 20p coin they would know it was fake.) Cash must also have security features to ensure that it is difficult to make forgeries (e.g. the Bank of England has introduced features such as raised print, metallic thread, micro lettering, watermarks, holograms, ultraviolet features, see through windows and complicated designs to the notes it issues.) Some of these features, such as watermarks and metallic thread, are easy for merchants to verify; others such a ultraviolet features require specialist equipment
Features of money: stable
Money needs to hold its value so people can be confident that the money they accept now will be worth the same or a similar amount in the future. Inflation, which is when the general level of prices in an economy rise, means that the same amount of money will buy less in the future and so its value falls in real terms
Features of money: divisible
Coins and banknotes must be provided in a variety of denominations so that people can use them in different combinations to make transactions of different sizes. Having smaller denominations allows people to pay with larger amounts of cash and to receive change. Payments from bank accounts are for specific amounts and therefore do not need to be divisible
