Topic 2:    What is Money?
At the end of the lecture, students should be able to:
1. Explain the meaning and functions of money
2. Describe the evolution of the payments system
3. Describe the difference between the United States and Hong Kong in terms of the definitions of money
2.1 The Meaning of Money
time is money
A. Money is defined as anything that is generally accepted in payment for goods or services or in the repayment of debts. Throughout the history of the world, many things have served as money. Examples include gold, silver, cows, horses, cigarettes, etc.
B. Distinction among money, wealth, and income
● Money includes only currency and coin outsides the banking system and demand deposits that are used to make purchases.
● Wealth is the total collection of pieces of property that serve to store value. Wealth includes not only money but also other assets such as bonds, common stocks, art, land, furniture, cars, and houses. Both Money and wealth are stock concepts, measured at a given point in time.
● Income is a flow of earnings per period of time.
2.2 Functions of Money
Whether money is shells or rocks or gold or papers, it has three functions in any economy: as a medium of exchange, as a unit of account, and as a store of value. Of the three functions, its function as a medium of exchange is what distinguishes money from other assets such as stocks, bonds, and houses.
A. Medium of Exchange
By being "generally acceptable as payment for goods and services", money serves as a physical means of conducting transaction. In the absence of money, we would be struck bartering for goods and services we want. This is inefficient and costly because it requires a “double coincidence of wants” -- people have to find someone who has a good or service they want and who also wants the good or service they have to offer. The time spent trying to exchange goods or services is called a transaction cost. Due to the "double coincidence of wants" problem, transaction costs in a barter economy are particularly high. 
For a commodity to function effectively as money, it has to meet several criteria:
● Be easily standardized to ascertain its value
● Be widely accepted by buyers and sellers
● Be easily divisible to make change
● Be easy to carry
● Not deteriorate quickly
The use of money as a medium of exchange promotes economic efficiency by minimizing the time spent in exchanging goods and services; and allows purchases and sales to be conducted independently which encourages specialization and division of labour.
B. Unit of account
Money is used to serve as a yardstick in measuring value in exchange. Money as a unit of account reduces transaction costs of exchange in an economy by reducing the number of prices that need to be considered. The benefits of this function grow as the economy becomes more complex.
C. Store of value
It is the repository of purchasing power over time, i.e. to save your income today to spend in the future. Money is not unique as the store of value. Many assets such as stocks, bonds, land, houses, art or jewelry have advantages over money to perform this function:
They often pay the owner a higher return than money.
However, there are significant costs associated with the conversion of money into other assets and then into money, such as paying commission for selling a house. Money is the most liquid asset because it is the medium of exchange. However, in times of high inflation or political instability, money may not be a good store of value.
Liquidity refers to the relative ease and speed with which an asset can be converted into a medium of exchange.
2.3 Evolution of the Payments System
The payments system has been evolving over centuries, and with it the form of money.
A. Commodity money
Originally, money took the form of commodity money. Commodity money is money with its own value as a good. Gold coins are commodity money because the gold is worth somet
hing as a precious metal. The problem with a payments system based exclusively on commodity money is that such a form of money is very heavy and is hard to transport from one place to another.
B. Fiat money
The next development in the payments system was paper currency (pieces of paper that function as a medium of exchange). Initially, paper currency carried a guarantee that it was convertible into coins or into a quantity of precious metal. However, currency has evolved into fiat money, paper currency decreed by governments as legal tender (meaning that legally it must be accepted as payment for debts) but not convertible into coins or precious metal. Paper currency has the advantage of being much lighter than coins or precious metal.