What Is Money?
Money is anything widely accepted in payment. It performs three functions, a medium of exchange, a unit of account, and a store of value. Economists measure the money stock with monetary aggregates, the narrow M1 (currency plus checkable deposits) and the broader M2.
Why it matters
Without money, trade needs a double coincidence of wants, so you have to find someone who has what you want and also wants what you have. A common medium of exchange removes that friction, and once everyone prices in it, it becomes the unit of account too.
Worked examples
A bank moves $1,000 of your checking deposit into a 12-month time deposit. How do M1 and M2 change?
M1 falls by $1,000 because a checkable deposit leaves the narrow aggregate, but M2 is unchanged because the time deposit still sits inside the broader M2. Money shifts between aggregates rather than changing total M2.
Common mistakes
- ✗Money is the same as wealth or income. Money is the stock of assets used for payment, while wealth is all assets and income is a flow over time.
- ✗Only cash is money. Checkable deposits are money too, and they make up most of the narrow M1 aggregate.
Revision bullets
- •Three functions: medium of exchange, unit of account, store of value
- •Solves the double coincidence of wants
- •Measured by aggregates: M1 (narrow) and M2 (broad)
Quick check
Which is NOT one of the three functions of money?
Connected topics
Sources
- Mishkin (2018), Ch. 3Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.The meaning and functions of money and the monetary aggregates M1 and M2.