Money performs four specific functions, each of which overcomes the difficulties of barter.

The
functions of money are to serve as:

1. Unit of value,
2. Medium of exchange,
3. Standard of deferred payments and
4. Store of value.

Money as a Unit of Value

The first function of money is to be a unit of value or a unit of account. The monetary unit is the
unit in terms of which the value of all goods and services is measured and expressed. The value
of each good or service is expressed as a price, which is the number of monetary units for which
the good or service can be exchanged.

If the price of a pen is Rs. 10 then a pen can be had in exchange for ten monetary units (where
the monetary unit in this case is the rupee). Measuring values in monetary units helps in
measuring the exchange values of commodities. If a pen is worth Rs. 10 and a notebook is worth
Rs.20 then a notebook is worth two pens. Further, accounting is simplified, as all items will be
recorded in terms of monetary units that can be added and subtracted. Money is a useful
measuring rod of value only if the value of money itself remains constant. This is similar to
saying that a scale is a useful measure of length only if the length of the scale itself is constant.
The value of money is linked to its purchasing power. Purchasing power is the inverse of the
average or general level of prices as measured by the consumer price index etc. As the general
price level increases, a unit of money can purchase a lesser amount of goods and services - so the
value or purchasing power of money declines. So, money will be a useful unit of value only as
long as its own value or purchasing power remains constant.

Money as a Medium of Exchange

Money also acts as a medium of exchange or as a medium of payments. This function of money
is served by anything that is generally accepted by people in exchange for goods and services.
'Anything' has been quite a variety of things across places and times. Some of the things that
have served as money are - clay, cowry shells, tortoise shells, cattle, pigs, horses, sheep, tea,
tobacco, wool, salt, wine, boats, iron, copper, brass, silver, gold, bronze, nickel, paper, leather,
playing cards, debts of individuals, debts of banks, debts of governments, etc. Money will then
reduce the time and energy spent in barter. The person who owned a cow can now simply sell it
to the person who offers the most money for it and then buy the bullock cart from another person
who offers him the best bargain. Ultimately, all trade may be considered barter - one good or
service is traded for another good or service -either directly, or indirectly with money acting as
the intermediary. However, by acting as an intermediary, money increases the ease of trade.
Money is also called a bearer of options or generalised purchasing power. This indicates the
freedom of choice that the use of money offers. The owner of the cow need not procure goods
and services from those to whom he sold his cow. He can use the money to buy the things he
wants most, from those who offer him the best bargain (not necessarily those who bought his
cow), at the time he considers most advantageous (not necessarily immediately). Again, this
function can only be performed properly if the value of money remains constant.

Money as a Standard of Deferred Payments

If money performs the previous two functions then it may also perform the function of being the
unit in terms of which deferred or future payments are stated. Examples of situations where
future payments are to be made are pensions, principal and interest on debt, salaries etc. As long
as money maintains a constant value through time, it will overcome the problems associated with
making future payments with specific commodities.

Money as a Store of Value

If money becomes a unit of value and a means of payment then it may also perform the function
of serving as a store of value. The holders of money are holders of generalised purchasing power
that can be spent through time. They know that it will be accepted at any time for any good or
service and is thus a store of value. This function will be performed well as long as money
retains a constant purchasing power.

It may be noted that any asset other than money may also perform the function of store of value,
for example, bonds, land, houses, etc. These assets have the advantage that, unlike money, they
yield income and may appreciate in value over time. However, they are subject to the following:

(1) they may involve storage costs,

(2) they may not be liquid in the sense that they could not be quickly converted into money
without loss of value, and

(3) they may depreciate in value. A person may choose to store value in any form depending on
considerations of income, safety and liquidity.

Functions of Money
Money is often defined in terms of the three functions or services that it provides. Money serves
as a medium of exchange, as a store of value, and as a unit of account.
Medium of exchange. Money's most important function is as a medium of exchange to facilitate
transactions. Without money, all transactions would have to be conducted by barter, which
involves direct exchange of one good or service for another. The difficulty with a barter system
is that in order to obtain a particular good or service from a supplier, one has to possess a good or
service of equal value, which the supplier also desires. In other words, in a barter system,
exchange can take place only if there is a double coincidence of wants between two transacting
parties. The likelihood of a double coincidence of wants, however, is small and makes the
exchange of goods and services rather difficult. Money effectively eliminates the double
coincidence of wants problem by serving as a medium of exchange that is accepted in all
transactions, by all parties, regardless of whether they desire each others' goods and services.

Store of value. In order to be a medium of exchange, money must hold its value over time; that
is, it must be a store of value. If money could not be stored for some period of time and still
remain valuable in exchange, it would not solve the double coincidence of wants problem and
therefore would not be adopted as a medium of exchange. As a store of value, money is not
unique; many other stores of value exist, such as land, works of art, and even baseball cards and
stamps. Money may not even be the best store of value because it depreciates with inflation.
However, money is more liquid than most other stores of value because as a medium of
exchange, it is readily accepted everywhere. Furthermore, money is an easily transported store of
value that is available in a number of convenient denominations.

Unit of account. Money also functions as a unit of account, providing a common measure of the
value of goods and services being exchanged. Knowing the value or price of a good, in terms of
money, enables both the supplier and the purchaser of the good to make decisions about how
much of the good to supply and how much of the good to purchase.

1. Money as a Medium of Exchange:

The function of money as a medium of exchange solves all the difficulties of barter system. There is no
necessity for a double coincidence of wants in the money economy. The man with cow who wants to
purchase cloth need not seek a cloth seller who wants a cow. He can sell his cow in the market for
money and then purchase cloth with the money obtained.

2. Money as Measure of Value:

In money economy values of all commodities are expressed in terms of money. Money is like the yard
stick of cloth merchant, as yard-stick measures all varieties of cloth, money measures the value of all
varieties goods. This function of money makes transactions easy and also fair

3. Standard of Deferred Payment:

In a money economy the contracts are made for future payments terms of money instead of goods and
promise to repay the loan in money. In this way money is the standard of deferred payments. This
function stimulates all kinds of economic activities wjtich depend on borrowed money.

4. Money as a Store of Value:

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.
5. The essential or primary functions of money are:
a) To serve as medium of exchange.
b) To serve as a measure of value.

The later two functions are of secondary importance because they; derived functions. In modern
economy, money plays a very important role. Its disappearance would cause disappearance of the
economy itself.

We say traditionally that money has four major functions. It is a

medium of exchange
Whatever people usually give in exchange for the things that they buy is the medium of
exchange. As we have seen, this is the function that defines money.
unit of account
The unit of account is the unit in which values are stated, recorded and settled. The
differences between this and the medium of exchange may seem subtle, but there are a
few cases in which the unit of account is different from the unit in which the medium of
exchange is expressed. In Britain a few decades ago, Guineas were often used as the unit
of account, while the medium of exchange was expressed in Pounds. Both Guineas and
Pounds in turn could be expressed in shillings -- the Pound was 20 shillings and the
Guinea was 21 shillings. (British currency has since been redefined).
standard of deferred payment
This is the unit in which debt contracts are stated. Deferred payment means a payment
made in the future, not now. Here, again, it is usually the same as the medium of
exchange, but not always. During periods of inflation, people may accept paper money
for immediate payment, but insist on some other medium, such as real goods and services
or gold, for deferred payment -- because the medium of exchange would lose much of its
value in the meanwhile.
store of value
Again, this is something that people keep in order to maintain the value of their wealth.
Again, while it would usually be the same as the medium of exchange, in inflationary
times other media might be substituted, such as jewelry, land or collectable goods. In this
sense, money is "set aside" for the future.

Three Functions of Money

Summary:   Money has to serve three basic functions -- as a medium of exchange, a unit of
accounting, and a store of value -- in order to be considered as money.

When people think of money, they think of bronze and silver coins, green, crisp, dollar bills, and
checks. They are used to get what people want. However, money is much more than that. It
includes cowrie shells that were used in Africa and gold coins that were used in Europe. In fact,
money is anything that serves three functions. It must be used as a medium of exchange, a unit of
accounting, and a store of value.

Money must be used as a medium of exchange. It must be universally accepted in order for it to
be used. It is a commodity or a token that everyone must accept in exchange for the things that
they need to or want to sell. Today, we use paper money and coins as our "money." Laborers
offer their hard work in exchange for money, which they can use whenever they want to get
whatever they want. But before our time, the people didn't have "money, so they bartered. They
exchanged from farm animals to elaborately designed and hand-made rugs to get the things they
wanted. However, bartering wasn't very efficient because it was hard to get both the seller and
the buyer to agree to the exchange. Whatever the buyer offered as "payment" may not have been
what the seller wanted or agreed to. Therefore, today, paper money and coins can be used as
money because it can be universally accepted and exchanged for a good or service.

The next function of money is the unit of accounting. Money must be something that can be used
to measure the worth or value of goods and services. Every country uses a different unit to
measure this worth or value. In the United States, we use the "dollar" and "cent." In Japan, they
use the "yen." In France, they call it the "franc." So within the country the single unit makes it
easier to make transactions and compare goods and determine their values. It can also help with
keeping accurate financial records like recording transactions, debts, profits, and losses.

Last of all is that money has to be a store of value. For example, if and employer paid his/her
employee with food for their services, then the employee would have to eat it then or then it will
spoil. So what if the employee wasn't hungry? Therefore, employers pay their employees with
money (bills, checks) and that money can be stored in a bank, as cash, etc., to be used later. Then
the employee could go out and buy food when he actually was hungry. So even though people
get paid at their jobs bimonthly or monthly, but they can spend their money at different times.
However, one problem with storing money is that it is not very efficient in times of rapid
inflation, when the value of money decreases. Otherwise, money is something that can be easily
stored and still have the same value.

In conclusion, money has to serve all three functions in order to be considered as money. It has
to be a medium of exchange, a unit of accounting, and a store of value. Medium of exchange
means that it is accepted in exchange for a good or service. As a unit of accounting, it makes it
more convenient to compare, value, and make transactions. As a store of value, people can get
money, store it, and then spend it whenever they want because the value is still there. All of these
are functions are important and can also be the reason why bartering failed and people decided to
turn to the idea of "money."

MONEY FUNCTIONS:

Any item used as money in an economy automatically takes on four basic functions: (1) medium of
exchange, (2) unit of account, (3) store of value, and (4) standard of deferred payment. While "buying
and selling" means that money is THE medium of exchange, and by far THE most important function of
money, money also performs unit of account, store of value, and standard of deferred payment
functions.
Money provides four key functions for an economy: (1) medium of exchange, (2) unit of account, (3)
store of value, and (4) standard of deferred payment. Medium of exchange means that money is used to
conduct transactions. Unit of account, also termed measure of value, means that prices are stated in
terms of money. Store of value means that value, the satisfaction of wants and needs, can be stored
over time using money. Standard of deferred payment means that future payments, such as paying off a
car loan, are also in terms of the monetary unit.

Medium of Exchange
THE primary function of money is to act as THE medium of exchange. People use money to buy and sell
goods. Buyers give up money and receive goods. Sellers give up goods and receive money. Money makes
transactions easier because everyone is willing to trade money for goods and goods for money.

To see why money makes transactions easier, consider a barter economy that has no money,
where one good is traded directly for another. The key to successful barter trades is double
coincidence of wants, each trader has want the other wants and wants what the other has.
Without double coincidence of wants, a barter economy can become exceedingly inefficiency.
Traders spend more time seeking trades and less time producing goods.

Suppose, for example, that Duncan Thurly heads into town with a basket full of hand-crafted
hamster hats (not hats made FROM hamsters, but hats made FOR hamsters) which he hopes to
trade for a pair of knickers--what others might call pants. If the local knicker-maker (Kevin)
needs hamster hats, the there is a double coincidence of wants and they are ripe for a trade.
However, if Kevin the tailor has no desire to acquire hamster hats, then there is NOT a double
coincidence of wants and Duncan does NOT get his knickers.

At least he will not get his knickers without spending some time, perhaps a great deal of time,
seeking to trade his hamster hats to someone else for a good that the tailor does desire. Duncan
might need to seek out dozens of other people, conducting dozens of intermediate trades, before
he finally has a good that can be traded for knickers. The time he spends on barter trades is time
that he CANNOT spend fabricating additional hamster hats, to the loss of hamster owners
worldwide.

Money eliminates the need for double coincidence of wants because EVERYONE is willing to
accept money in payment for goods. Duncan can trade his hamster hats for money (that is, sell),
trade this money for the knickers (that is, buy), then returned home for further hamster-hat
fabrication. With a generally accepted medium of exchange, trades are easier, more efficient, and
resources can spend more time doing production.

Unit of Account
The second function means that is money is being used as the common benchmark to designate the
prices of goods throughout the economy. Unit of account, or measure of value, means money is
functioning as the measuring unit for prices. In other words, prices of goods are stated in terms of the
monetary unit.
If Duncan Thurly is heading off to the market in search of hamster hats or tailored knickers, then
he will find each has a price in terms of the medium of exchange. If his society make use of U.S.
dollars, then hamster hats carry a U.S. dollar price. If he lives in a land that uses German marks,
then knicker prices are in terms of marks--German marks.

The reason is that sellers are willing to trade for, and buyers are willing to give up, THE medium
of exchange--money. That is why money is THE medium of exchange. It is used for exchanges.

Using money as the unit of account for prices, however, also provides a measure of value--how
much value buyers and sellers place on a good. If tailored knickers carry a $10 price, while
hamster hats go for $5 each, then this indicates a measure of the relative value of each
commodity--knickers have twice the value of hamster hats. Buyers are willing to give up twice
as much money to buy a pair of knickers as to acquire a hamster hat and sellers incur twice the
opportunity cost of producing a pair of knickers as that of hamster-hat production.

Store of Value
The third function, store of value, emerges because money is one way of postponing the satisfaction
obtained from using or consuming goods until a later time. Value is obtained from a good when it is
consumed, when it is used to satisfy wants and needs. The value from consuming goods can be stored in
several different ways, one of the best is money.

Consider a few ways that Duncan Thurly might be able to store the value of a $2 hot fudge
sundae for one week.

 First, he could buy a freshly fabricated hot fudge sundae for $2 and store this product for seven
days. Successful storage requires a freezer, especially during the summer. Would this hot fudge
sundae retain its full $2 value one week hence? Probably not. The hot fudge is likely to be cold.
The whipped topping is probably unwhipped.

 Second, Duncan could purchase a $2 gift certificate from the ice cream parlor, a coupon that is
tradeable for one hot fudge sundae. After a week, he can redeem the certificate and enjoy his
treat. In this case the value of the sundae is stored in the coupon. While this is a relatively good
store of value for the hot fudge sundae, it ONLY stores the value of a hot fudge sundae. A hot
fudge sundae coupon cannot be used to store the value of other goods.

 Third, he could take his $2, use it to purchase another good, like a book, hold onto it for a week,
sell it, then use the proceeds to buy a hot fudge sundae. Of course, if the book is not very liquid,
meaning that it cannot be easily converted into money, then he probably will not end up with
the $2 that he needs to buy his hot fudge sundae. Storing the value of one good by purchasing
then later selling another good is seldom the best way to go.
  Fourth, Duncan could simply keep $2 stashed away in his billfold, sock drawer, or coffee can
buried in his back yard. After one week, he can then amble down to the ice cream parlor with
this $2 in hand to make his hot fudge sundae purchase. In this case, he has stored the delicious
value of the hot fudge sundae in the form of money.

The problem with storing value in money is price changes. If the price of the hot fudge sundae rises
during this week, then Duncan's money becomes a less effective means of storing value. As a general
rule, price inflation is the nemesis for the store of value function of money.

Standard of Deferred Payment

This fourth function means money is used as a standard benchmark for specifying future payments for
current purchases, that is, buying now and paying later. This function may seem obscure, but it is a
direct result of the store of value and unit of account functions.

A common example of deferred payments is a car loan. Duncan Thurly get a loan to buy a car
today, then pay off the loan with payments deferred into the future. The amount of those future
payments are stated in terms of money.

Using money as a standard of these deferred payments is a direct consequence of the unit of
account and store of value functions of money. If money is the standard for current prices, then
money is also the standard for future payments based on those prices. But, for money to function
as a DEFERRED payment standard, it must retain value, it must store value. The key to storing
value in money is price inflation.

This means that deferred payments need to anticipate future money values based on future
inflation. If inflation is, for example, 10 percent next year, then deferred payments need to be
adjusted for the resulting decline in money value. This inflation adjustment is accomplished by
through interest rates.

Functions of money
The basic function of money is to enable buying to be separated from selling, thus permitting
trade to take place without the so-called double coincidence of barter. In principle, credit could
perform this function, but, before extending credit, the seller would want to know about the
prospects of repayment. That requires much more information about the buyer and imposes costs
of information and verification that the use of money avoids.