What is money?
Money is anything that is generally accepted as payment for goods and services. It makes buying and selling much easier because people do not have to swap goods directly.
Simple idea: money is useful because almost everyone accepts it in exchange for goods, services and debts.
The barter system
Before money was widely used, people often used barter. The barter system means exchanging one good or service directly for another good or service, without using money.
For example, a farmer might exchange vegetables with a tailor in return for clothes. The problem is that barter needs a double coincidence of wants. This means both people must want exactly what the other person is offering.
- Problem 1: It is difficult to find someone who wants your product and also has what you want.
- Problem 2: It is hard to measure value. For example, how many apples equal one pair of shoes?
- Problem 3: Some goods are difficult to divide. You cannot easily divide a cow into small pieces for different trades.
- Problem 4: Some goods do not store well. Food may rot before it can be exchanged.
Forms of money
Money can exist in different forms. Students often think money only means notes and coins, but in modern economies most money is held in bank accounts.
Cash
Cash means notes and coins. It is physical money that people can hold and use for small daily payments, such as buying food, bus tickets or stationery.
Bank deposits
Bank deposits are money held in bank accounts. People use this money through debit cards, online transfers, cheques and mobile banking.
Central bank reserves
Central bank reserves are electronic balances that commercial banks keep at the central bank. They are mainly used by banks to settle payments between each other and to keep the banking system stable.
Characteristics of money
For something to work well as money, it must have certain features. These characteristics help people trust and use money easily.
| Characteristic | Meaning | Simple example |
|---|---|---|
| Durability | Money should last for a long time and should not be easily damaged. | Coins last longer than fresh fruit, so coins are better money than fruit. |
| Acceptability | People must be willing to accept it as payment. | A shop accepts local currency because people trust its value. |
| Divisibility | Money should be easy to divide into smaller amounts. | A $10 note can be divided into smaller notes or coins as change. |
| Uniformity | Each unit of money should be the same as another unit of the same value. | One $5 note should have the same value as another $5 note. |
| Scarcity | Money should not be available in unlimited amounts, or it will lose value. | If too much money is created, prices may rise and money may buy less. |
Easy memory tip
- Durable: it lasts.
- Acceptable: people trust it.
- Divisible: it can be split into smaller values.
- Uniform: each unit is the same.
- Scarce: it is limited enough to keep value.
The functions of money
Money performs four main functions in an economy:
- Medium of exchange: money is used to buy and sell goods and services. For example, a customer uses money to buy a school bag.
- Unit of account: money gives a common measure of value. For example, prices allow us to compare the cost of a pen, a book and a laptop.
- Store of value: money can be saved and used later, as long as it keeps its value.
- Standard of deferred payment: money can be used to settle debts in the future, such as loan repayments.
The banking system
Banks are important because they help money move around the economy. They connect savers, borrowers, businesses and the government.
Functions of commercial banks
Commercial banks are banks used by households and businesses. Their main aim is usually to make profit, but they also provide important services that support everyday economic activity.
- Accept deposits: they keep money safe in current accounts and savings accounts.
- Provide loans: they lend money to households and firms for things such as homes, cars, machinery or business expansion.
- Make payments easier: they provide debit cards, online banking, mobile transfers and other payment services.
- Offer financial services: they may provide mortgages, credit cards, foreign exchange and advice.
Functions of central banks
The central bank is the main bank of a country. It does not usually serve ordinary customers like a commercial bank. Instead, it manages the banking system and helps control the supply of money and credit in the economy.
- Issues currency: it is responsible for issuing the country's notes and coins.
- Banker to the government: it manages government accounts and helps with government financial operations.
- Banker to commercial banks: commercial banks hold reserves at the central bank and use them to settle payments.
- Lender of last resort: it can lend to commercial banks in emergencies to prevent a banking crisis.
- Monetary policy: it influences interest rates and the money supply to help control inflation and support economic stability.
- Supervises the banking system: it helps make sure banks operate safely and the financial system remains stable.
| Commercial bank | Central bank |
|---|---|
| Serves households and businesses | Serves the government and commercial banks |
| Accepts deposits and gives loans | Issues currency and manages monetary policy |
| Aims to earn profit from services and lending | Aims to keep the banking system and economy stable |
| Examples of services: debit cards, mortgages, savings accounts | Examples of functions: lender of last resort, bank supervision, managing reserves |
Quick exam tip
If the question asks about money, first define money as something generally accepted as payment. Then explain one function, one form or one characteristic with an example.
If the question asks about banks, make sure you separate commercial banks from the central bank. Commercial banks deal mainly with the public. The central bank manages the banking system.
Quick check
- Barter means swapping goods directly without money.
- The main forms of money are cash, bank deposits and central bank reserves.
- Good money should be durable, acceptable, divisible, uniform and scarce.
- Commercial banks accept deposits, lend money and provide payment services.
- Central banks issue currency, supervise banks and help manage money and credit in the economy.
