What is Money?

The most common answer to the question “What is Money?” is simply the notes and coins in your pocket. However, it you take those to another country, you will have trouble spending them in shops. Also, you are able to buy things with your credit card, so is a credit card money?

Economists try to define money by listing its functions like a store of value, a medium of exchange, etc. But many things fall within these criteria. The best definition of money is a measure of value. Just like a ruler measures length, money measures utility.

Before the invention of money, people had to trade using barter, swapping one good for another. So a pair of shoes may cost half a sheep but a jacket costs 50 carrots. How do you decide what to buy? It gets even more complicated because you can’t trade your sheep directly for carrots. You have to make a chain of matching wants to get the carrots to buy the jacket. Little wonder trade was limited to necessities.

The introduction of money resolves this problem. Instead of thinking of dollars, imagine they are happiness points. When you decide to by an item there is always an opportunity cost, something else to buy. For example, if you have a $100 (100 happiness points) you could buy a pair of shoes or a jacket. Which do you choose? Subconsciously you will think the shoes give me 130 happiness points whereas the jacket only gives 120 points. So you choose the shoes to maximise your utility.

What you use as money does not matter. Some cultures have used shells, gold, paper, tobacco, etc. The important factor is that it is a stable measure. Imagine building a house when a foot was literally the length of the king’s foot. If the king dies, the new king will have a different shoe size. Changing your tape measure half way through is going to result in a wonky house.

Like any measuring stick, money needs a reference point to make it a fixed measure. Just like a foot is set at 12 inches, a dollar was fixed at an amount of gold. This meant the money supply was controlled by the rate gold is mined. But now that everyone pays taxes, a dollar is now fixed at a dollar of tax. Enabling governments to influence the money supply to try and keep prices stable.