Medium of Exchange

Any medium of exchange must also serve as a store of value. This just means that money should keep its value between the time that you receive it (in exchange for goods that you sell or work that you do) and you spend it again. If an object lost all or most of its value over a short period, then it would not be acceptable in exchange. So something that serves as money must be a store of value. Imagine for a moment an economy in which ice played the role of money. Except on the coldest days, the ice you receive on payday would not last long enough for you to buy anything with it. It would be a terrible store of value and, as a result, would not do a good job of facilitating exchange. Paper money and coins are not like ice. They are durable and do not dissolve with use. Because of this, you can be confident that the dollar you have in your pocket today will still be a dollar you can spend tomorrow. The fact that people are willing to hold money for long periods of time is indicative of the role of money as a store of value. If money were not a store of value, then all people would want to get rid of cash as soon as they received it. To mix our metaphors: if money were ice, it would become a hot potato. Being a store of value is more than just a physical property of money. Currency in your pocket can remain there for a long periods of time before disintegrating. So, in a physical sense, that currency retains its worth. But, if prices are increasing, then in terms of what the currency can buy, the money in your pocket is not retaining its value. In times of inflation, money functions less well as a store of value. Unit of Account Almost universally, prices are quoted in terms of some currency, such as pesos, dollars, or euros. Goods and services sold in the United States have prices in terms of US dollars. The dollar serves as a unit of account. But when the very same goods and services are sold in Europe, they are priced in a different unit of account: euros. This role of money is so familiar as to be mundane, yet our economy simply could not function without a commonly accepted monetary measuring stick. It would be like building a house without an accepted measure of length or running an airline without an accepted measure of time. The unit that people use to keep account of their monetary transactions varies from country to country. In Mexico, prices are quoted in pesos, in India prices are quoted in rupees, and so on. In most countries, the medium of exchange and the unit of account are the same thing, but this need not be true. Because the US dollar is known throughout the world, it is often used as a unit of account in unexpected places. Prices of commodities in international transactions may be quoted in terms of the dollar even when the transaction does not directly involve the United States. Luxury hotels in China and elsewhere sometimes quote prices in US dollars even to guests who are not coming from the United States. [3] As another example, after the changeover to the euro, that currency became the medium of exchange and the “official” unit of account. But many people—at least in terms of their own thinking and mental accounting—continued to use the old currencies. In everyday conversation, people continued to talk in terms of the old currencies for months or even years after the change.[4] Even today, some bills and bank statements in Europe continue to quote the old currency along with the euro.