Macroeconomics: Defining Money

Cowrie Shell

A durable shell used as a medium of exchange from 700 BC into the 1900s.

Barter

Trading one good or service for another without using money.

Double Coincidence of Wants

A situation where two people each want the good or service the other can provide.

Baker and Butcher Example

Adam Smith's hypothetical barter scenario in The Wealth of Nations used to motivate the use of money.

Four Functions of Money

Medium of exchange, store of value, unit of account, and standard of deferred payment.

Medium of Exchange

Whatever is widely accepted as a method of payment.

Store of Value

Something that preserves economic value to be spent or consumed in the future.

Unit of Account

The common way in which we measure market values in an economy.

Standard of Deferred Payment

Money accepted to make purchases today that will be paid in the future.

Commodity Money

An item used as money that also has value from its use as something other than money.

Commodity-Backed Currencies

Currencies with values backed up by a physical commodity like gold or silver.

End of U.S. Gold Standard

1971, when the gold standard backing the U.S. money supply was ended.

Fiat Money

Money with no intrinsic value that is declared by government decree to be legal tender.

Backing of Modern U.S. Currency

Universal faith and trust that the currency has value, backed by the Federal Reserve.

Silver Certificates

U.S. currency backed by silver until 1958.

Gold and Silver

Examples of commodity money that possess intrinsic value from uses other than as currency.

Myth of the Barter Economy

The historical misconception that a pure barter economy was a common precursor to the invention of money.

Legal Tender

By government decree, a currency that must legally be accepted to pay off debts.

The Federal Reserve

The institution that backs modern U.S. bills as fiat money.

Barter Inefficiency

The necessity of a double coincidence of wants, making trade difficult without money.

M1 Money Supply

A measure of the money supply that includes currency, demand deposits, and other checkable deposits.

M2 Money Supply

A broader measure of the money supply that includes M1 plus savings deposits, time deposits, and money market funds.

Role of Banks

Financial intermediaries that connect savers who have excess funds with borrowers who need funds.

Balance Sheet

An accounting tool that lists assets on one side and liabilities on the other.

Bank Capital

A bank's net worth, calculated as total assets minus total liabilities.

Reserves

Funds that a bank keeps on hand rather than lending out or investing, including cash in the vault.

Money Multiplier Formula

The formula 1 divided by the reserve requirement, used to calculate how banks create money through lending.