Money: Definition, Classification, Uses & Examples (2024)

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Money is something that we think about every day and it is a huge part of our existence, yet somehow most of us don't know the full definition of it, what all of its functions are, and why it even has so much power over us all. The full extent of what money is, all its different forms and purposes might surprise you! If you are interested in learning more about money, you've come knocking at the right door! Now, let's take a look.

What is Money?

Money, in its simplest form, is a tool that facilitates the exchange of goods and services. It acts as a universally accepted medium of exchange that allows us to buy a loaf of bread, book a holiday, or even purchase a house, without needing to barter. So, instead of trading your home-grown tomatoes for a haircut, you simply hand over some money!

Bartering is when parties exchange goods without using money but choose which goods to exchange based on their intrinsic values.

Definition of Money

Let's take a look at economic definition of money:

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context.

Imagine you're an artist who paints beautiful canvases. Your neighbor loves your work and wants a painting, but all she has to trade are guitar lessons, and you don't have an interest in learning guitar. So, instead of you two being at a standstill, she gives you money for your painting. You can then use this money to buy something you do want, like piano lessons from someone else.

Currency vs Money

Money and currency often seem interchangeable, but they hold unique roles in the economic system. Think of money as a concept: it's a medium of exchange that allows us to purchase goods and services without needing to swap items directly. On the other hand, currency is a physical representation of money, like coins and bills, that a government has declared legal tender.

Currency refers to the physical notes and coins that are in circulation and recognized by a society as a medium of exchange.

There are also two groups that money is split into. We call these groups M1 and M2. M1 is composed of actual currency, which is paper money and coins, and checkable deposits which are deposits made into commercial banks into either checking or savings accounts that can be withdrawn. M2 includes M1 and near-monies which are assets that are highly liquid that cannot be used as money directly but can be converted into usable money rather quickly.

Fig 1. Components of M1 and M2

Economics of Money

The economics of money, also known as monetary economics, is a branch of economics that examines the various theories behind money, and how money functions. The economics of money looks into the different types of money and how it works as a form of compensation. It also examines how monetary policy affects the economy and can be used to improve efficiency. A goal of monetary policy is to help an economy maintain stability, grow, and develop. Money is an important factor in the economy not just from an economic standpoint but also from a personal one. It is economically important because it pushes economic growth and stimulates the economy to be more productive. On a personal level, it allows society to purchase what it needs such as food, shelter, and healthcare.

To learn more about monetary policy, check out our explanation - Monetary Policy

Characteristics of Money

The characteristics of money are what give money its value. In this case, money is currency. The three main characteristics are its acceptability, its status as legal tender, and its relative scarcity. The benefit of money is that it is portable and replaces the need to carry around tradable goods such as gold, furs, or spices which are heavy and can go bad over time. Having a paper note or lighter coin that has a standardized value and is widely accepted makes trading infinitely easier. This standardized value also means that it can be easily divided into smaller units of account such as halves, quarters, fifths, and tenths.

Acceptability

The acceptance of cash or checkable deposits as compensation or money is partially what gives it its value. Acceptance is the first step to legitimizing anything as money because if a government or a society does not want to accept the money as payment, this suggests that it does not hold value or at least is not in a form that is acceptable to them.

An example of acceptability would be when you are paying at the grocery store, they accept cash, credit or debit card, or food stamps. However, if you went in with the title to your car or a gold ring they would have a hard time accepting it because it is not liquid currency. No doubt both of these items hold value, but they are not accepted as currency.

Legal Tender

The second characteristic of money is its use as legal tender. This is when money has been backed by a government as a legal form of payment for any personal or private debts. This adds to the credibility and acceptability of money. U.S. Dollars all have the phrase, "this note is legal tender for all debts, public and private," written on them.

Of the different types of money, fiat money and commercial bank money are what the modern world is most familiar with since they are what are currently in use in developed nations such as the U.S. and European countries. Commodity money was often used in the past when societies were moving away from strict bartering systems and moving toward more convenient ways to engage in trade.

Example of Money

Let's take a look at an example of money. There are many different shapes and forms that money can take all around the world. Different nations use different currencies to represent their nation's wealth.

In the United States, the currency used is the United States Dollar. It comes as both paper notes and coins, the paper notes being mostly uniform in size and color but with varying designs intended to indicate the values they are representing such as $1.00, $5.00, $10.00, $50.00, or $100.00. The coins are more unique in their composition of metals and sizes such as zinc, nickel, and copper.

The United States is not the only country that uses its currency. Several countries like Ecuador, Panama, and Puerto Rico use the U.S. Dollar instead of a unique currency because the U.S. Dollar is stable and backed by a stronger economy, providing those nations with stability. Other nations choose to band together to share a currency to achieve a more stable economy with their common trading partners and promote collective economic growth and integration. An example of this would be the Eurozone.

The Euro Zone is a collection of 19 countries collectively agreeing to use the same currency: The Euro. This expedites and simplifies trade between the nations of the Eurozone which provides stability and an opportunity for economic growth. The Euro comes in denominations of €5.00, €10.00, €20.00, €50.00, €100.00, €200.00, and €500.00 (although the €500 notes are no longer issued). There are €1.00 and €2.00 coins, along with 1, 2, 5, 10, 20, and 50 cent coins.

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