The Free Market Center
The Free Market Center
A precise definition of money helps the understanding of its role.
Money consists of any economic good, or any claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment.
That's it.
Other uses of money—frequently cited as characteristics of money:
are not unique to money.
In spite of its ubiquitous nature, money seems to be one of the most misunderstood concepts in economics. Although we classify it as an economic good, because it exists in relatively limited quantities and people want it for economic activity, it adds nothing to the well-being of economic actors. Money, for that reason, plays a unique role from other economic goods.
Although many people define money as a medium of exchange, it is critically important to remember that money is a medium of indirect exchange. In its role as a medium of indirect exchange, money acts to facilitate exchanges. In the case of loans, in which borrowers and lenders exchange current goods for future goods, money provides the medium for that particular indirect exchange.
Because money adds no utility of its own, there is no reason to increase the quantity. Increasing the quantity of money does not improve its role of facilitating exchanges. In fact, changes in the quantity of money detracts from it role in exchanges. Changing the quantity of money would be analogous to changing the length of the yardstick when measuring distances at different points in time.
As a medium of indirect exchange, money plays the important role in the pricing mechanism of conveying critical market information.