The three functions of money

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Two sorts of money exist:

1) Fiat money is a money that has no intrinsic value (i.e. it is not made of anything valuable) but that has a nominal value by decree of the government. For example, all paper currencies are fiat money. Inflation results from the issuing of too much fiat money by a government.[1]

2) Specie, on the contrary, does have an intrinsic value. For instance, gold or silver coins are specie because those are two precious metals.

Money serves three functions:

1) Medium of Exchange = it resolves the "double coincidence of wants problem", that is the unlikelihood of finding someone who has what I want and wants what I have. By accepting a common medium of exchange, people make transactions more likely to happen.

2) Store of value = it allows individuals to convert perishables (such as food) into more durable goods that can be stored and saved in between two transactions.

3) Unit of Account = it provides a standard relationship between various goods and services in the economy, thereby facilitating transactions.[2]

References

  1. http://www.investorwords.com/1928/fiat_money.html
  2. Morrison, James A. "International Monetary Exchange in Theory." Oct 12, 2010. Middlebury College