Common Sense Economics: What Everyone Needs to Know about Wealth and Prosperity
Money is vitally important for the operation of an economy. Most importantly, money is a means of exchange. It reduces transaction costs because it provides a common denominator into which the value of all goods and services can be converted. Money also makes it possible for people to gain from complex exchanges with a time dimension, such as the sale or purchase of a home or car, which involve the receipt of income or payment of a purchase price across lengthy time periods. And it provides a means to store purchasing power for future use. Money is also a unit of account that enhances people’s ability to keep track of benefits and costs, including those incurred across time periods.
The productive contribution of money, however, is directly related to the stability of its value. In this respect, money is to an economy what language is to communication. Without words that have a clearly defined meaning to both speaker and listener, communication would be difficult. So it is with money. If money does not have a stable and predictable value, it will be difficult for borrowers and lenders to find mutually agreeable terms for a loan, saving and investing will involve additional risks, and time-dimension transactions (such as payment for a house or automobile) will be fraught with additional uncertainty. When the value of money is unstable, many potentially beneficial exchanges are not made and the gains from specialization, large-scale production, and social cooperation are reduced.
There is no mystery about the cause of monetary instability. Like other commodities, the value of money is determined by supply and demand. When the supply of money is constant or increases at a slow, steady rate, the purchasing power of money will be relatively stable. In contrast, when the supply of money expands rapidly compared to the supply of goods and services, the value of money declines and prices rise. This is inflation. It occurs when governments print money or borrow from a central bank in order to pay their bills.
- The reason governments ended up with the task of creating money (coining or printing), is because governments were the most reliable source for money. But today, that is sometimes not the case. Some countries use other countries’ currency, instead (often the U.S. dollar, but sometimes others). Today, there are other options, as well. Bitcoin, and related crypto currencies are one example.
- Do you think having multiple, competing, currencies would be a good idea? What are the downsides?
- One of the consequences of high inflation is that people have trouble finding ways of saving. Either they consume everything they earn, or they get creative. For instance, buying durable goods like washing machines, even if they don’t plan on using them for a while, or for themselves.
- If you had to buy something to save income, what would you buy? What are some things you use often, which keep their value over time? Would smartphones work? If not, why not?
This reading is an excerpt from Certell’s Common Sense Economics eBook. Certell offers curriculum materials and eBooks free of charge for students and teachers. Click here to download the Common Sense Economics.
27, Sept. 2018, Pictures depicting inflation with wheelbarrows of money [Digital image and photogrpah]. Retrieved from <google.com>.