142 ❯ Step 4. Review the Knowledge You Need to Score High
KEY IDEAIn general, money is anything that is used to facilitate exchange of goods between buyers
and sellers. Human history has seen many things used as money, from shells and tobacco to
gold and spices. These different forms of money have all performed certain functions.Financial Assets
We have already discussed investment in physical (or capital) assets like machinery or new
construction as components of GDP. The firm invests in a physical asset if the expected
rate of return is at least as high as the real interest rate. Sometimes firms and households
seek other forms of assets as a place for their money. Financial investments also yield a rate
of return. We spend much more time discussing money as a short-term financial asset, but
quickly address other financial assets like stocks and bonds.Stocks
A share of stock represents a claim on the ownership of the firm and is exchanged in a stock
market. Firms that wish to raise money for capital investment can issue, and sell, these
partial shares of ownership. This form of equity financing avoids debt but relinquishes a
small degree of control over the management, and profits, of the firm.Bonds
A bond is a certificate of indebtedness. When a firm wants to raise money by borrowing,
it can issue corporate bonds that promise the bondholders the principle amount, plus a
specified rate of interest, with repayment on a specific maturity date. This form of debt
financing commits the corporation to interest payments, but does not relinquish shares of
ownership. Like stocks, bonds can be bought and sold in a secondary market. We shall see
how the central bank can intervene in this market in a way that has profound effects on
the economy.Functions of Money
In general, money is anything that is used to facilitate an exchange of goods between buyers
and sellers. Human history has seen many things used as money, from shells and tobacco
to gold and spices. These different forms of money have all performed certain functions.
Today’s paper and coin money is called fiat money because it has no intrinsic value
(like gold) and no value as a commodity (like tobacco). It serves as money because the
government declares it to be legal tender and, in doing so, the government assures us that
it performs three general functions:
• Medium of exchange. Your employer exchanges dollars for an hour of your labor. You
exchange those dollars for a grocer’s pound of apples. The grocer exchanges those dol-
lars for an orchard’s apple crop, and on and on. If it weren’t for money, we would still
be engaging in the barter system, an extremely inconvenient way to exchange goods and
services. If I were a cheese maker and I wanted apples, I would need to find an orchard
that also needed cheese, and this would be a supremely difficult way to do my shopping.
• Unit of account. Units of currency (dollars, euro, yen, etc.) measure the relative worth
of goods and services just as inches and meters measure relative distance between two
points. Again, this is an improvement over the barter system where all goods are meas-
ured in terms of many other goods. The value of a pound of cheese in a barter economy
is measured in a dozen eggs, or a half pound of sausage, or three pints of ale. With
money, the value of cheese, and all other goods and services, is measured in terms of a
monetary unit like dollars.
• Store of value. So long as prices are not rapidly increasing, money is a decent way to store
value. You can put money under your mattress or in a checking account, and it is still