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Money is one of man’s greatest inventions and the fact that all but the least developed of human societies use money indicates that it is an essential tool of civilization. In the absence of some form of money, exchange may take the form of barter which is the direct exchange of goods and services for goods and services. Barter will serve man’s requirements quite adequately when he provides most of his needs directly and relies upon market exchanges for very few of the things he wants. As the extent of specialization increases, the barter system proves very inefficient and frustrating.
The great disadvantage of barter is the fact that it depends upon “a double coincidence of wants”. A hunter who wants to exchange his skins for corn must find, not merely a person who wants skins, but someone who wants skin and has a surplus of corn for disposal. The alternative is to exchange his skins for some other article and they carry out a series of similar exchanges until he finally gets his corn. Time and energy which could be devoted to production is spent on a laborious system of exchange.
Quite earlier in his history man discovered a much more convenient arrangement. The use of some commodity as a medium of exchange makes exchange triangular and removes the major difficulty of the barter system. If a commodity is generally acceptable in exchange for goods and services, it is money. A producer now exchanges his goods for money and the money can be exchanged for whatever goods and services he requires.
Let’s take up the functions of money!
A medium of exchange.
As I have already explained, the use of money as a medium of exchange makes possible a great extenuation of the principle of specialization. In an advanced society the use of money allows us to exchange hours of labor for an amazing variety of goods and services.
A measure of value.
The first step in the use of money was probably the adoption of some commodity as a unit of account or measure of value. Money, most likely, came into use within the barter system as a means whereby the values of different goods could be compared. The direct exchange of goods for goods would raise all sorts of problems regarding valuation. The problem of exchange rates is easily solved when all other commodities are valued in terms of a single commodity which then acts as a standard of value. Money now serves as such a standard and when all economic goods are given money values, we know, immediately, the value of one commodity in terms of any other commodity.
A store of value.
Once a commodity becomes universally acceptable in exchange for goods and services, it is possible to store wealth by holding a stock of this commodity. It is a great convenience to hold wealth in the form of money. And the great disadvantage of holding wealth in the form of money has become very apparent in recent years – during periods of inflation its exchange value falls.
A means of making deferred payments.
An important function of money in the modern world, where so much business is conducted on the basis of credit, is to serve as a means of deferred payment. When goods are supplied on credit, the buyer has immediate use of them but doesn’t have to make an immediate payment. The goods can be paid for three, or perhaps six, months after delivery.
So the means of money in our life is tremendous. We use them everywhere in case the situation is connected with buying or exchanging goods, but also with storing wealth and social happiness.