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© 2014 Pearson Canada Inc.#
Explain how cigarettes could be called "money" in prisoner-of-war camps of World War II.
Answer: The cigarettes performed the three functions of money. They served as the medium of
exchange because individuals did exchange items for cigarettes. They served as a unit of account
because prices were quoted in terms of the number of cigarettes required for the exchange. They
served as a store of value because an individual would be willing to save their cigarettes even if
they did not smoke because they believed that they could exchange the cigarettes for something
that they did want at some time in the future.
Diff: 2 Type: SA Page Ref: 47 - 50
Skill: Applied
Objective List: 3.2 Distinguish among the three primary functions of money
Can packs of cigarettes be used as commodity money?
Answer: We must see whether cigarettes satisfy the 5 criteria for a commodity to function
effectively as money:
- Easily standardized—yes they are, cigarettes come is packs.
- Widely accepted—yes, if they are used in a setting such as WW II prisoners of war.
- Divisible—yes, packs of cigarettes are divisible to single cigarettes.
- Easy to carry—yes, cigarettes are lightweight.
- Must not deteriorate quickly—yes, cigarettes do not deteriorate easily.
Diff: 2 Type: SA Page Ref: 47 - 50
Skill: Applied
Objective List: 3.2 Distinguish among the three primary functions of money
Economists say that money is a store of value. since there are other assets that are a more
desirable store of money, why do people hold money at all?
Answer: People hold money although it is not the best store of value, because of an important
economic feature of money, liquidity. Liquidity is a highly desired property of assets. Liquidity
measures how easily and fast an asset can be converted into a medium of exchange. Since money
is a medium of exchange it is the most liquid asset, and thus, highly desirable although it is not
the best store of value.
Diff: 2 Type: SA Page Ref: 49 - 50
Skill: Applied
Objective List: 3.2 Distinguish among the three primary functions of money
Why are people are willing to hold money even if it is not the most attractive store of value?
Answer: The answer to this question relates to the economic concept of liquidity, the relative
ease and speed with which an asset can be converted into a medium of exchange. Money is the
most liquid asset of all because it is the medium of exchange; it does not have to be converted
into anything else in order to make purchases. Other assets involve transaction costs when they
are converted into money.
Diff: 2 Type: SA Page Ref: 49 - 50
Skill: Applied
Objective List: 3.2 Distinguish among the three primary functions of money