Concept of Money

What they say about money?

 Research shows that the more money people have, the
more likely they are to report being satisfied with their
lives.
 Money buys you things that make life easier and more
satisfying; the easier your life, the happier you tend to
be.

That relationship isn't entirely linear, since there's a

limit to how much wealth can please you; the happiness
benefit of an increasing income is especially powerful
among people who don't have much money to start
with, and diminishes as wealth increases.
 What is Money?
• Money is that which is
universally acceptable in
an economy and used as a
medium of exchange (i.e.,
accepted as payment for
purchases of goods and
services or for a debt).
 What is Money?
• It is any object that is
commonly accepted,
spendable and authorized by
the state as a means of
exchanging products and
services in a certain place and
time.
• It is also defined as anything
which has a fixed and
unvarying price in terms of
the unit of account (ex.
dollar, peso, etc.).
 Money as an Asset
• Money can be considered an asset, or something
of value. As such it is part of your wealth (Net
worth = Assets – Debt).
– Although not the only form of wealth
exchangeable for goods and services, money is
the one most widely accepted (liquidity).
• An asset is liquid when it can be easily exchanged
for goods and services.
– Money is the most liquid of all assets.
 Money and Prices (Inflation)
• Another key economic variable is the price level
and how it changes.
– Inflation – is defined as the rise in the
(weighted) average of all prices.
• One theory attributes inflation to changes in the
amount of money in circulation.
– Studies show that increases in the growth of the
money supply leads to an increase in the
inflation rate.
 How was money invented?
• Money was invented because of the failure of the
barter system. (Barter – is the trade of goods and
services for another without the use money.)
– A barter system typically would involve an
exchange of commodities (ex. exchanging 3
chickens for 1 goat, a pair of shoes for a blouse,
so on and so forth) between 2 or more people.
– The major problem facing a barter economy is
that a double coincidence of wants is required
for exchange.
 Shortcomings of a Barter System
• Shortcomings of a Barter System
– Absence of a method of storing generalized
purchasing power.
– Absence of a designated unit to use in writing
contracts requiring future payments.
– Absence of a common unit of measure and
value.
 Disadvantages of the Barter System
• Barter System
– Disadvantages:
• The limited shelf–life of goods, bad roads, and
the difficulty of transporting goods due to bulk.
• The near impossibility of matching the goods the
seller has with the needs of the buyers he/she
meets (double coincidence of wants).
• The problem of determining whether the value of
one product or service is equal to the value of the
product or service being exchanged.
 Purchasing Power, Explained
 Purchasing power – is the number of
goods/services that can be purchased with
a unit of currency.
• Explanation: If you had taken P10,000 to
a store in the 1990s, you would have been
able to buy a greater number of items
than you would today, indicating that you
would have had a greater purchasing
power in the 1990s.
 Evolution of Money
• At first, personal ornaments such as rare seashells
and stones were exchanged for food and other
commodities.

• As early as 3000 B.C., people discovered the

convenience of using precious metals – such as
gold and silver – as money.
 Bank Notes and Greenbacks
• A Bank Note – is a piece of paper that
represents a liability on the part of the
issuing bank to the holder – and not to a
specific payee.
 Functions of Money
• As Medium of Exchange
Money's most important function is as a medium of
exchange to facilitate transactions. Whatever people
usually give in exchange for the things that they buy is
the medium of exchange (such as a coin, or the paper
money). When money is used to intermediate the
exchange of goods and services, it is performing a
function as a medium of exchange.

Ex. A professor cannot arrange barter, i.e., exchange

his teachings in exchange for a haircut (from a barber).
Money is necessary to carry on exchange.
 Function of Money
• As a Unit of Account
A unit of account – is defined as a standard numerical
unit of measurement of the market value of goods, services,
and other transactions; the unit of account is the unit in which
values are stated, recorded and settled.
Money also functions as a unit of account, providing a
common measure of the value of goods and services being
exchanged.

Note: As a medium of exchange – money functions as

something real , ex. a coin, a piece of currency, a credit in a
bank account. But as a unit of account – money functions as
an abstract measure of value, ex. the dollar, the pound
sterling, etc.
 Function of Money
• The Liquidity Function
Liquidity – is defined as the degree to which an asset can
be sold for cash without a loss in nominal value; it also means
that the price of money is fixed and that money can be readily
exchanged for desired goods and services.
To be liquid the asset must be: (1) readily marketable or
transferable, and (2) stable in price.

Note: The essence of liquidity is the ability of an asset to be

converted into spendable form, immediate marketability (or
transferable) at a price certain.
 Function of Money
• As a Store of Value
Store of value – is defined as the ability of an item to
hold value over time. To act as a store of value, it must be able
to be reliably saved, stored, and be retrieved.
This is something that people keep in order to maintain
the value of their wealth. Money is "set aside" for the future.
Goods cannot be stored because they are perishable. People
receive their incomes in money form and keep their savings in
money form in banks. In this way, money is used to store
value of commodities.

Note: The price of money is fixed (ex. $1, $5, $10, $50, and
$100) but its value may change over time, since economic
activity takes place under conditions of change and
uncertainty.
 Kinds of Money and their
Characteristics
• Commodity money
An exchange medium representing value; a
material established as a standard of value and used
legally in settling debts because of its intrinsic value.

• Credit money
Any claim against a person, used for the
purchase of goods and services, and is not
immediately repayable.
 Kinds of Money and their
Characteristics
• Fiat money
Money declared by the government as
legal tender. Fiat money is paper money
that is backed only by the issuing
government's decree that it is acceptable as
“legal tender” currency.

Note:In a fiat money system, money is

not backed by a physical commodity (e.g.,
gold). Instead, the only thing that gives the
money value is its relative scarcity and the
faith placed in it by the people that use it.
 Kinds of Money and their
Characteristics
Cont'd. (Fiat money)

Today, money typically consists of coins, paper,

currency and checking account balances.
In the past, societies have most often chosen a
precious metal or coin as money, ex. gold and silver.
 E-Money and its Forms
Since money is what is accepted as money, in
practice money assumes different forms.
Technological changes in the banking industry
lead to changes in the form of money.
For these reasons money is difficult to define and
measure.
 Forms of Electronic Money
• Debit Cards
A bank card used to make an electronic withdrawal
from funds on deposit in a bank, as in purchasing
goods or obtaining cash advances.
• Stored Value Cards
A credit card with a built-in microprocessor and
memory that is loaded with cash.
• Electronic Checks
A form of payment made via the internet that is
designed to perform the same function as a
conventional paper check.
 Other Forms of Money
• Coins and currencies (called paper money or
notes) – are the most common form of money
which one can hold and touch; physical
objects.
• Bank checks or drafts: Money can also be
any other object that represents value such as
a manager's check or a gift certificate.
Notes: Bank checks or drafts are different
with money in a sense that coins and
currencies are anonymous (if one will tell
who owns it or where it came from).
Ownership of a bank check/draft can be
 Desirable Properties of Money
1. Durability
Money that does not have the quality of
physical durability will lose its value as money.
 Desirable Properties of Money

2. Portability
Money must be easy to carry around and easy
to transfer in order to make purchases in different
locations.
If money is not portable, it cannot be widely
used.
 
 Desirable Properties of Money
3. Homogeneity (or Standardizability)
A commodity from which it is made must be of
the same quality wherever it can be found.
Only if money is standardized can individuals
be certain of what they are receiving when they
make economic exchanges.
 Desirable Properties of Money
4. Divisibility
Money must be easily divided into equal parts
to allows for purchases of smaller units.
 Desirable Properties of Money
5. Recognizability
Money must be easily recognized. If it is not
easily recognized, individuals will find it difficult
to determine whether they are dealing with money
or some inferior asset.
 The Monetary Standard
Monetary Standard – is the set of monetary
arrangements and institutions governing the supply of
money.

2 Aspects of Monetary Standards:

1. Domestic aspect - refers to the institutional
arrangements and policy actions of monetary
authorities.
2. International aspect - refers to monetary
arrangements between nations.