4.3 Definition, Measurement, and Functions of Money
Money is anything widely accepted as payment. It serves as a medium of exchange, unit of account, and store of value, and is measured by M1 and M2.
Money performs three functions: a medium of exchange (it buys things, eliminating barter's double coincidence of wants), a unit of account (prices are quoted in it), and a store of value (it holds purchasing power over time). If an exam question asks why inflation is costly, one answer is that it erodes the store-of-value function.
Commodity money (like gold) has value in itself; fiat money (like the U.S. dollar) has value only because the government declares it legal tender and people accept it. Modern economies run on fiat money.
The Fed measures money by liquidity. M1 is the most liquid — currency in circulation plus checkable and other liquid deposits (savings deposits count in M1 since 2020). M2 adds near-monies: small time deposits (CDs) and retail money market funds. Every M1 dollar is also in M2.
Key terms for 4.3
Counting credit cards as money. A credit card creates a loan you must repay — it is not a store of value and appears in neither M1 nor M2.
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