Understanding Money (Cambridge (CIE) IGCSE Economics): Revision Note

The meaning of money

• Prior to the creation of money, individuals and firms had to accept other goods or services as payment, or be self-sufficient by producing everything required

  • Lacking self-sufficiency or driven by the desire for a wider range of goods and services, bartering became the norm but it too had problems

• As individuals and firms trade with each other in order to acquire goods or raw materials, they require a means of exchange that is acceptable and easy to use 

• Modern currency fulfils this purpose

The forms of money

1. Cash – coins and banknotes used for everyday transactions

2. Bank deposits – money held in bank accounts, accessible via cheques, debit cards, or online transfers

3. Electronic money – digital payments, mobile banking, and online currencies

4. Near money – assets that can be quickly converted into cash (e.g. savings accounts)

The functions of money

• In order to be effective, modern currency has to fulfill four uses (functions)

The four functions of money

1. A medium of exchange

• Without money, it becomes necessary for buyers and sellers to barter (exchange goods)

• Bartering is problematic as it requires two people to want each other's goods (double co-incidence of wants)

• Money easily facilitates the exchange of goods, as no double co-incidence of wants is necessary

2. A measure of value (unit of account)

• Money provides a means of giving a value to different goods and services

• Knowing the price of a good in terms of money allows both consumers and producers to make decisions in their best interests

• Without this measure it is difficult for buyers and sellers to arrange an agreeable exchange

3. A store of value

• Money holds its value over time (of course inflation means that is not always true!)

• This means that money can be saved

• It remains valuable in exchange over long periods of time

4. A method of deferred payment

• Money is an acceptable way to arrange terms of credit (loans) and to settle any future debts

• This allows producers and consumers to acquire goods in the present and pay for them in the future

The characteristics of money

• Many items were used for centuries as a form of money, such as gold, silver, shells, beer and tobacco

• However, each one of these items had some characteristics that made them less than ideal for exchange in certain circumstances

• Good money has a number of essential characteristics – and modern currency fulfils them all 

Divisibility

• To be a valued medium of exchange, currency must be divisible. €50 notes can be exchanged for €10 euro notes or €1 coins

Acceptability

• The currency must be valued and widely accepted by society as a valid way to pay for goods/services

Durability

• The currency must be robust, not easily defaced or destroyed and last for a long period of time

Scarcity

• The supply of the currency should be such that it remains desirable and retains its value in the market. Oversupply would decrease its worth

Uniformity

• In order to be a valid measure of value, each denomination must be exactly the same, e.g., every $50 note must be exactly the same

Portability

• Good currency is easy to carry or conceal