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History of Money

History of Money

Author: Kate Eskra
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This lesson covers the History of Money
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Tutorial

HISTORY OF MONEY

Source: Image of bank notes, public domain, http://en.wikipedia.org/wiki/File:Billets_de_5000.jpg, Image of check, creative commons, http://en.wikipedia.org/wiki/File:Sweet_success.jpg, Image of White Traders Bartering with Indians, public domain, http://en.wikipedia.org/wiki/File:Trade_with_indians_1820.jpg, Image of Barter – Chickens for Subscription, public domain, http://en.wikipedia.org/wiki/File:Barter-Chickens_for_Subscription.jpg

Video Transcription

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Hi. Welcome to macroeconomics. This is Kate. This tutorial is on the history of money. As always, my key terms are in red, and my examples are in green. So in this tutorial, we'll talk about the three functions of money, which are a medium of exchange, a store of value, and a unit of account. We'll talk about the problems with a barter system. And we'll see the use of commodities as money. And we'll talk about which commodities meet the three functions the money the most efficiently.

So if you were asked the question what is money? You would probably answer that you think of it as bills, or coins, checks, something along those lines. But in this tutorial, we're going to talk about, is that what money has really always involved? If we broadly define money, isn't it just anything that lets us get what we want, what we don't have right now? That's what money is. And so a good money serves three functions. It serves as a medium of exchange, a store of value, and a unit of account. Let's look at each of these separately.

So a medium of exchange is the first function that money has to serve. It's an item used as an intermediary in non-barter based trade, and it's going to facilitate trade. So what do we mean by that? This is what's helping us to get what we want. So when I go to the grocery store, I'm not bartering. I'm not exchanging something that I have for my groceries. I'm going to use my debit card to pay for those groceries. It is acting as a medium of exchange, because it's an acceptable form of payment to trade for what I want-- my groceries. My debit card is linked to my checking account, takes out the money there, and that money is acting as a medium of exchange.

A store a value is a slightly different function of money. It's an item having a recognized value that can be stored and retrieved. So I'm not always using my money right now to purchase something that I need. When I do, that's acting as a medium of exchange. But when I'm not using my money right now to purchase what I need, I store some of it in my savings account. I know that my money there isn't going anywhere. It's going to be stored safely. And it will retain its value. And I can access it later, whenever I need to. That is a store of value.

A unit of account is the third function of any money. And this is an item used in financial transactions and record keeping. So once a money becomes an acceptable form of payment, like the dollar is in our country-- it's our current form of currency-- things are then quoted in dollars. So this is used in financial transactions and to help keep records. And really, the example I gave is it provides a way for us to compare the value of things. If I know that this is a certain price in dollars, and that is another price in dollars, I can compare. I know whether I'm getting a good deal on something, because it was a certain amount of dollar somewhere, and it's on sale here for fewer dollars. So that is what we mean by a unit of account.

So we didn't always have money as the form of currency. We engaged in barter. So before money, people would barter for what they needed. And barter is just exchanging one item for another. This picture here is showing white traders bartering with the Indians. And we've all, in history classes, learned stories about their exchanges of items.

So this man here, again, going back in history, is trying to buy his newspaper subscription for the year with chickens. Because that's what he had, and what he wants is a newspaper subscription. So this dates back to 1874. And barter has worked in many economies throughout history, but it can be really inconvenient. One of the biggest problems with barter is, it's called the double coincidence of wants.

So let me give you an example in my life. Let's say that we didn't have money. I have no money, but I need desperately a haircut. OK. So what can I give? Well, I have the ability to tutor. I'm skilled in tutoring people in economics. So I don't have money, but eh, if I can find someone who needs some tutoring services in economics, then maybe I can convince them to give me a haircut.

The problem is, geez, that's not going to be very easy. I'm going to need to take a lot of time finding a hairdresser who is willing to accept my economics tutoring as a form of payment. So my tutoring services, more than likely, are probably not a great medium of exchange in most cases. Right? Because it's going to be hard for me to find someone who needs that specific thing.

Because of the time wasted trying to find someone who has what you want, and also wants what you have, people started trading commodities. So a commodity is something that has value in and of itself, because it's a useful in an economic system or in that society. And because of its use, it's pretty easy to trade it.

So here are some examples of commodity monies that have been used over time. Salt. If you think about, salt had a huge value before refrigeration as a way to preserve things. Shells, large stones, cigarettes, and alcohol. I think cigarettes today are still used in prison as a form of payment for things. Barley, cocoa beans, cotton in the South was used as a commodity. Gold, and silver, and copper.

If we think about this list of commodities-- and there are many more, I just picked a few-- which are a good medium of exchange? So which would be easy to use to purchase the things that you want? Well, I personally wouldn't want to lug around large stones with me to use them as a medium of exchange. It would be pretty hard, also, if you had a really large stone, to trade that for something small. Right? It wouldn't be very divisible. I would think that some of these wouldn't really last forever. Like maybe barley isn't going to last a very long time. Shells. Are they all going to look the same? So that's going to be difficult.

And then what about a store of value? So the store of value. Is it going to retain value over time? Like I said, barley might not last very long. So which of these are a good medium of exchange and a good store of value? Eh. What do you think? Well, the better commodities were the ones that were portable, so easy to carry around, durable, so they retain their value and didn't spoil, and divisible.

So people might value large stones, but they're not necessarily easy to carry around, nor easy to divide, like I said. Something like milk is going to spoil really quickly, so that would not serve as a good store of value. But gold and jewels-- so it turned out that the silver, the copper, the gold and jewels are kind of easy to transport and they don't spoil. So they turned out to be the most efficient of the commodities.

So many people began, then, using gold as a medium of exchange. As that happens, it then begins to serve that third purpose as a unit of account. And people could start citing prices of items in terms of goals. So this is worth so many ounces of gold, that's worth so many ounces of gold. And now, people can perform those financial transactions and record financial transactions using gold as a unit of account.

So in this tutorial, we looked at those three functions of money as a medium of exchange, store of value, and unit of account. We talked about the double coincidence of wants and the problems, the time that is wasted with a barter system. And then finally, we looked at some commodities used as money and talked about which commodities meet and don't meet those three functions of money the most efficiently. Thanks so much for listening, have a great day.

Notes on "History of Money"

Terms to Know

  • Medium of Exchange
  • An item used as an intermediary in non-barter based trade; facilitates trade.
  • Store of Value
  • An item having a recognized value that can be stored and retrieved.
  • Unit of Account
  • An item used in financial transactions and record keeping.