Some people may think that money's function is limited to one use — to buy things. Money actually has three functions, all of which make legal tender a practical form of payment. These three functions allow money to be durable, exchangeable, and valuable.
- A medium of exchange. Money is used as a medium of exchange because it is an efficient way to allocate resources. Economies have goods and services that need to be allocated to people. The best way to do this is to establish a structured currency. If we didn't have currencies, people likely would be bartering (or stealing!) their way through life. Economics as we know it would take on a different role, one that involved a survival of the fittest.
- A unit of account. Money helps us understand relative values of goods and services. We can gauge how much a day of work is worth in terms of goods and services. The value of a diamond ring can be distinguished from the value of shoes. Money allows us to determine how valuable labor and wages are relative to goods and services.
- A store of value. We can exchange money for a good or service at any time without worrying about our money expiring. Our currency doesn't rot, wither, or melt away. It can be kept for long periods of time without a loss of exterior value. However, the value money holds in terms of what goods and services it can purchase varies as a result of the fluctuating forces of supply and demand.
You should be aware of two types of money for the AP exam:
- Fiat money: Money that is decreed by the government as an acceptable means of exchange for goods and services.
- Commodity money: Money that has intrinsic value (in other words, it's worth its weight in a precious metal). Gold, silver, and any other precious metal is considered commodity money.