Most people don't spend much time wondering what money is, their major concern is how much they have, and how to get more. Usually, the question of what money IS arises only when money ceases to function properly. In economics (properly understood), the answer to the question - what is money? - consists of three words:
That's all. Yet the conception of a "medium of exchange" ranks below only language (with its corollaries - speech and the written word) as the greatest intellectual discovery in history. Without language, the exchange of anything but the most rudimentary ideas is impossible. Without money, the production and exchange of anything but the most rudimentary goods and services is impossible. It is not difficult, or time consuming, or inefficient, it is IMPOSSIBLE!
Animals don't exchange (or trade) amongst one another. They are self-sufficient, or they take from each other, or they exercise the prerogative of superior strength and/or cunning. There are some human beings who get along in a very similar fashion, but the overwhelming majority recognise the benefits of voluntary exchange. Strictly speaking, the use of the word "voluntary" in this context is redundant. The phrase "your money or your life" is not the precursor to an exchange, whether the person uttering it brandishes a gun or a government identity card.
The first rule of any voluntary exchange is simplicity itself. If two people are willing to exchange, each must view the results of the exchange as being beneficial. If either of them is not of that view, the exchange will not take place.
Direct exchange, or barter, is exactly that - my good or service for your good or service. The problem is that I might want what you have to offer, but you might not want what I offer in exchange. With no "medium" of exchange, there is no deal. Indirect exchange takes place when one party has a "medium" that is always acceptable, not for what it is, but for what can be done with it. If you offer me money, I will accept it, because I know that I can exchange it for what I want, whenever I want it.
Indirect exchange involves the use of MONEY - the "medium" of exchange. Money is the universal key, it fits all locks. And the world it has unlocked is the world we live in today. Money has made the division of labour possible. It has made specialisation possible. It has made the accumulation of wealth over periods which exceed a human lifetime possible. Perhaps most important of all, it has hugely advanced the potential for amicable interaction between people. To survive as such, and to prosper, a rational animal must exchange. He or she has language, to exchange ideas, and money, to exchange the fruits of ideas. From that foundation, everything else we see around us has been built.
What is money? It is a medium of exchange. What does it do? It ensures the success of exchange by being the one item on offer that is ALWAYS acceptable. Why is it necessary? Because human beings must exchange to live together in peace, and to prosper. How important was the discovery of the idea of money? Look around you.
That covers the concept or idea of money. But an idea, as such, does not exist as a physical entity. Money must be a physical entity. Neither the "electronic" money of today nor the notes and coin which circulate as cash has any official or legal connection with Gold and Silver. But they once did, and most people think that they still do. As long as that situation persists, the modern monetary system will function.
Now, how does one go about choosing what is to be used as money? Simple, one looks for the most tradeable good, the good which is in highest demand, the good that has begun to be accepted, not as an end in itself, but as a means to an end. Money is the good that people do not want to consume, but want to use to make further exchanges easier.
Human beings have lived together for more than two million years. Money in its modern form - coin of fixed weight and denomination - came into use less than three thousand years ago. It took a long time to discover the physical good which best serves the purpose of a medium of exchange.
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