The three main primary functions of money include medium of exchange, unit of account, and store of value. These are explained below:
Medium of exchange
this function allows money to be used to pay for goods and services. The use of money for the exchange of goods and services allows for efficiency in the economy by reducing the problems and time wasted in the process of barter trade. We can say use of money as a medium of exchange reduces the transaction costs. The characteristics of money that reduces transactional costs include:
- Money is standardized and is easy to ascertain its value
- Money is usually accepted
- Money is easily divisible, when one wants to change
- Money is easy to carry
- Money is durable and cannot deteriorate quickly
Unit of account
This function suggests that money is used to measure value in the economy. The value of goods and services in the economy is measured through money, like a pen cost R3-00. In the barter trade, it was going to be difficult to get the value of goods and services. All prices in the economy are quoted in terms of units of money and thus money as a unit of account reduces transaction costs.
Store of value
Money sometimes is used as a store of value, for deferred consumption. In other words, a store of value is used to save purchasing power from the time income is earned until it is spent. Money is not the only asset that can be used as a store of value, many assets are available that can be preferred instead of money for the function of store of value. Stocks, bonds, land, and houses can be used as a store of value. The reason why money will be preferred to other assets is that money is the most liquid asset. Other assets incur transaction costs when they are converted into cash. Money is not the best form of asset to use as a store of value during inflationary periods, because the value of money is easily eroded by declining purchasing power in inflationary environments.
