(a) What is money? (b) Outline any three characteristics of money. (c) Explain an effect of inflation on each of the functions of money.

Answer Details

(a) What is money? Money is anything that is generally acceptable as a medium of exchange and for the settlement of debts. It performs the functions of a medium of exchange, a measure of value, a store of value and a standard of deferred payments.

(b) Three characteristics of money:

1. General acceptability - it must be accepted by everyone in payment.
2. Durability - it must not wear out or perish quickly.
3. Portability - it must be easy to carry about. (Other qualities: divisibility, homogeneity, relative scarcity and difficulty to counterfeit.)

(c) Effect of inflation on each function of money. Inflation is a persistent rise in the general price level, which reduces the value (purchasing power) of money. Its effect on the functions is:

• Medium of exchange: as prices rise, people lose confidence in money and may become reluctant to accept it, in extreme cases returning to barter or foreign currency.
• Measure (unit) of value: money becomes an unreliable yardstick because the same amount buys less over time, so prices must be constantly adjusted and comparisons become difficult.
• Store of value: money loses value when kept, so savers are discouraged; wealth held as cash falls in real terms.
• Standard of deferred payment: lenders and creditors lose because the money repaid in future has less purchasing power than the money originally lent, discouraging lending and long-term contracts.