The 3 main functions of money
Unit of account, Store of value, Medium of Exchange
What is a medium of exchange?
• A more efficient way to exchange products and services than the barter system (that otherwise
requires a “double coincidence of wants”)
• In this regard, money serves the role of an intermediary between the products or services that people want to trade
• What makes a good medium of exchange?
• Durability: Metals / gems vs. tobacco / chocolate
• Transportability: Paper money / electronic registers vs. metals / gems
• Divisibility: Metals / paper money vs. cattle
• Non-counterfeitability: A long-standing problem for almost all currencies
• Fungibility: Each unit is identical to others in its characteristics and functions. Paper money vs.
cattle/tobacco/cowrie shells
Unit of Account
What is a unit of account?
• A standard measurement of the value of goods, services, economic activities, assets and liabilities.
• A common unit of account is what allows us to compare:
• The value of 10 lemons vs. 1 book
• The financial results of a furniture manufacturer with those of an internet portal
• The size of the economy of Delaware with that of Rhode Island
• Stability: Stability of the value of the unit of account makes it more useful as a unit of account.
In inflationary currencies, for example, over long periods of time, results are not comparable, leading
to the need to use nominal (actual) vs. real (inflation-adjusted) values in order to make measurements
comparable again
• Does the Unit of Account have to be the same as the Medium of Exchange?
No! But usually it is. Some exceptions:
• Unidad de Fomento (UF) in Chile: A national indexed unit of account used to adjust for inflation
• External currency pegs: In high inflation countries, merchants have been known to post prices in dollars or
other stable currencies (the Unit of Account) but to settle in local currency at the current exchange rate (the
Medium of Exchange)
Store of Value
• What is a store of value?
• A store of value is a mechanism by which wealth can be saved and retrieved in the future with
some predictability about its future value
• Store of value is not a function solely of currencies, but of assets in general
• As all asset prices have greater or lesser degrees of unpredictability, there is no perfect store of
value
• What drives the ability of something to be a ‘store of value’?
• Current expectations of stable or predictably knowable future demand for the asset
• Current expectations of stable or predictably knowable future supply of the asset
Notable Stores of Value:
• Gold / Silver / Diamonds
• Reserve currencies and/or the bonds of reserve currency nations
• Stocks / Bonds / Real Estate
Note that all of these assets are subject to volatility and none are a perfect store of value