Money: 6

First, I will write about the three things that money does, which are: (1) acts as a medium for exchange, (2) stores value, (3) provides a metric for exchanges.  The first function of money combined with the third function of money provides people with a way to buy and sell and to have a sense of the value of the exchange in the process.  The second function of money gives a way of saving the value of a sale, to be used in future exchanges.

With regard to money as a medium of exchange, I would think that the ease with which a person can use money to buy things which the person values and can afford and the ease with which a person can receive compensation for labor or goods, greases the wheels of an economy.  With regard to money as a store of value, money is not a good store of value over time unless sufficient interest is paid on the money over time.  Because our economy has had persistent inflation over many years, the value in terms of buying power of a given quantity of money stored in earlier years has been less in the present than when first stored.  With regard to money as a metric for exchanges (a unit of account),  money measures value.  Because of inflation, the measure is not constant over time, but, at any given time, money measures the value of an exchange.

Next, I will write a little on to the neutrality of money.  According to my introductory economics book, early theorists in economics thought that money was neutral.  That is, if the money supply expanded, the expansion would not affect the quantity of goods produced, but would increase the prices of all goods by the same proportion, until all of the excess money was absorbed.  I believe that we now know that changing the money supply affects the economy.  I think that we have found that increasing the supply of money of money increases economic activity, which produces growth.  Certainly, the population is growing, so the money supply would need to grow just to stay even.  Also, the goods and services available for sale are always changing, so neutrality of money does not make sense with respect to a constant set of goods available.

Last, I will write a little on the velocity of money.  The velocity of money is a measure of economic activity (for example, the Gross Domestic Product) divided by a measure of the money supply (for example, M1).  The velocity of money is the number of time the money turns over within the economy within a time period.  In a day, say I buy some juice, the grocery store pays my friend, partly with the money that I spent at the store.  My friend buys some socks.  The money I spent on the juice has been spent three times during the day.  So the economic activity depends on both the money supply and the velocity of money.  If the velocity of money is higher, not as much of a money supply is needed for the same amount of economic activity.  See the Wikipedia entry, Velocity of Money, for a more complete explanation.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s