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What is Money: Types of Money and Money as Means of Exchange

Nuelson Penuel Tuesday, March 28, 2023 Basis

 

Summary

In this post, you will learn about what is money, money as a medium of exchange, how is money measured and types of money.

What is Money?

Money is a current medium of exchange or any item that is accepted generally as a form of payment in exchange for goods and services rendered. Money is a medium of exchange; it allows people and businesses to obtain what they want. Above all, money is a unit of account - a standard unit accepted by society in which all things are priced. The word money was derived from a Latin word ‘Moneta’ which means ‘coin’ The Latin word is believed to originate from a temple of Juno(a Greek goddess), on Capitoline, one of Rome's seven hills. In the ancient world, Juno was often associated with money. The temple of Juno Moneta at Rome was the place where the mint of Ancient Rome was found.[

Money as a Medium of Exchange

Before the development of money as a medium of exchange—people would barter to obtain the goods and services they needed. Two individuals, each having some goods the other wanted, would enter into an agreement to trade by exchanging their goods. Bartering, however, did not promote transferability and divisibility that makes trading efficient. For instance, if someone has meat but needs rice, they must find someone who not only has rice but also the need for meat. What if that individual finds someone who has the need for meat but no rice and can only offer wheat? To get rice, that person must find someone who has rice and wants meat. The barter system was full of difficulties of exchanging goods and services between individuals. In the absence of easy exchange of goods and services the barter system worked as an obstacle to division of labour among individuals which is an important factor for increasing productivity and economic growth. The problems faced by the use of the barter system gave rise to the use of commodity money. This term was first used in Mesopotamia circa 3000 BC. Commodity money consists of objects having intrinsic value as well as value in buying goods. The system of commodity money eventually evolved into a system of representative money. This occurred because of gold and silver traders and business or banks would issue receipts to their depositors – redeemable for the commodity money deposited. Eventually, these receipts became generally accepted as a means of payment and were used as money. Paper money or banknotes were first used in China during the Song dynasty. These banknotes, known as “jiaozi”, evolved from promissory notes that had been used since the 7th century. Today, the value of money is determined by its purchasing power which is in turn dictated by inflation. Money also has certain properties that allow for the smooth exchange of goods:
  1. It is exchangeable, so that it doesn't need to be re-valued for every transaction.
  2. It is durability: so that it can last for as much exchange as possible.
  3. Portability: It should be convenient to carry around.
  4. It should be recognizable so that people can trust it and confidently complete their exchanges of goods and services.
  5. Stability: the supply of money should be stable so that its value is reliable.
  6. Acceptability: it should be accepted everywhere.
  7. Scarcity: the amount of money in circulation should be maintained by the government so as to keep its value.

How is Money Measured?

Economists ask how much money is in circulation and in what form it is to determine whether there is inflation or deflation in a country’s economy. Money can be separated into different groups to help it be more recognizable in measurement procedure. M1- this includes all physical denomination of coins and currency used to buy and make payments. M2- This group represents money that can easily be transferred into cash M3- This includes all of the currency in circulation as well as liquid financial products, it also includes less liquid assets that cannot be easily converted to cash if needed urgently. These three groups make up the total amount of money in an economy.

Types of Money

Throughout time, there has been an evolution of different forms of money from seashells and seasonings to banknotes and debit cards. They are; Fiat money: Fiat money (fiat currency) is money whose value based on an authoritative decision (fiat) by the governing body. it does not have an intrinsic value and can be replaced by the governing body if damaged. The value of this money is derived from the relationship between supply and demand. Most modern economies use the fiat money system. It include coins and bills (paper money). Commodity money: It’s a type of money in which its value is defined by the intrinsic value of the commodity itself, that means the commodity itself becomes money. Unlike the fiat money it cannot be replaced once it is destroyed. The use of this type of money is similar to the barter system but unlike the barter system, the commodity money functions differently as it allows you to compare the worth of the goods and services. Eg gold etc. Fiduciary money: Deriving from the Latin word ‘fiducially, meaning to trust, fiduciary money works on the promise and trust that it will be exchanged for fiat or commodity money by the issuer (bank). People are not required to take it as a form of payment because it is not a government-ordered legal tender like the fiat money. It is also called representative money. It’s value is gained from being backed by a commodity or fiat money.examples of it include debit cards, bank draft, bank cheques etc. Commercial bank money: commercial bank money is debt generated by commercial banks that can be exchanged for real money or to buy goods and services. Commercial bank money is created through a process called fractional reserve banking. Fractional-reserve banking is a process whereby the banks give out a portion the money deposited by their customers on loan with a stipulated interest rate thereby making money from it.

Currency

It is money in the form of paper and coins issued by a government and generally accepted at face value as a method of payment for goods and services. It is a form of fiat money. Currency is the primary medium of exchange in the modern world, having replaced bartering as a means of payment for goods and services. In the 21st century, a new form of currency was brought as a means of exchange known as the virtual currency, also called cryptocurrency. Virtual currency includes ethereum, bitcoin, binance etc. Cryptocurrency is a digital payment system which is stored in digital wallets and is used to pay for goods and servics.It is called a cryptocurrency because of its ability to use encryption to verify transactions. According to Satoshi Nakamoto who is the founding father of Bitcoin, it is a peer-to-peer electronic cash system.

Uses of Cryptocurrency

As a mode of payment: It is used as a mode of payment for goods and services rendered. As a mode of money transfer: The use of cryptocurrency helps in sending and recieving money at a low cost and high speed. As an investment: It’s value appreciation is really great and has proved to be an excellent avenue to expand capital. However it is also very volatile and risky as a result of price fluctuations. One should know that in all forms of investment there is always a degree of risk attached. So we should always carry out a thorough research before going into any investment to avoid the risk of losing our money.

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