The two important topics of macroeconomics, money demand and money supply are based on particular function of money. Classical school of thought consider money as medium of exchange and according to this school demand for money is directly proportional to value of transaction. Whereas in keynesian and post keynesian school of thought several other function of money have been considered and is not limited to fulfilling transaction (medium of exchange). Let us discuss them one by one.
1) Medium of exchange:
In the article Barter system failure, we observed if we use gold, or property or farm produce to complete a transaction, we need to find a party/person who can accept them, at same time they should hold what we want, i.e double coincidence of wants. If the person already got (In abundance) what we are offering, she is not going to make a deal. Hence our search cost goes up in searching another party, thus lot of obstacles. Barter system need two party with diametrically opposite demand. Now with money as medium of exchange, we can sell our service or commodity in return for money. Later this money can be used to purchase goods of our need. Hence the issue of search cost and the double coincidence of wants are taken care of by money being medium of exchange.
2) Unit of account:
Let us go back to barter system once again. You exchange one kg rice for two kg wheat with your friend. So 1 kg wheat = half kg rice. Pretty easy to remember. Now your friend get 2 hand towel for 1 kg rice. 1 hand towel = half kg rice or 1 hand towel = one kg wheat.
In this example we have only used three commodities. Rice, wheat and hand towel. Thus it seems easy to remember each of their value in term of other. But what happens when there are thousands of commodities involved. One will have to look for a chart to exchange one thing for another. And what happens if in a particular year one commodity production or growth was at large scale. That will make the commodity relatively cheaper due to it’s abundance.
To remove all the confusion and to have a precise exchange rate for a commodity, money is used as unit of account. We can link price of wheat, rice, hand towel et cetra with money and money price with all these commodities. Say 1 kg wheat = 10 rupees (10 unit of money). 1 rupee (unit of money) = 100 gram or .10 kg wheat. So money removes all difficulties faced in measuring items in respect with different item and we simply assume it as a good and compare it with all other good.
3) Store of value:
Wealth in form of perishable item won’t last long. It’s value also decreases with time. Wealth in form of non perishable item will last long (gold, land etc.) but they may/may not be liquid (mostly takes time to go liquid) and lacks universal acceptablilty. Wealth in form of money has benefits: a) It is not perishable. b) It is easy to store and require less space. c) Most liquid form unless money is not stable (which is rare), hence acceptable to anyone.
Note: Rising inflation erode value of money, this leave us with more money but less purchasing power.
This one is relatively important in present age. Banks are giving loan to satisfy it’s customer present needs but also take back money with interest. We are spending money in share markets, bonds today so to get future payments. This is important money function, as it makes easy the process of lending and borrowing. Money also help us exchange goods or service for future payments, but of course with condition (read intention) of making profit.
Note: In inflationary times, the borrower benefits at the cost of lender and in deflationary times, lender benefits at the cost of borrower.