7.1: What Money Actually Does

Learning Objectives

• Describe the functions and traits that define money.
• Explain how money solves transaction complexity.
• Connect abstract economic concepts of monetary trust to real-life decision-making.

The Fiction That Works

Money is the starting point. Before we talk about saving, borrowing, or building wealth, we need to understand what money is and what it isn’t. Most people treat it as a given, like gravity or Wi-Fi. It is always there and rarely questioned. However, upon examining its function and design, money becomes one of the most fascinating and fragile systems humans have ever created.

Before we talk about debt, credit, savings, or spending, we need to get something straight: Money isn’t a thing. It’s a shared idea—one so powerful and so trusted that it shapes everything around it.

Money has no value on its own. You can’t eat it, wear it, or build shelter out of it. But with enough of it, you can access all those things and more. It works only because we agree it works. The dollar in your wallet, or the number on your banking app, is a promise. What gives that promise power is belief, reinforced by habit, tradition, and systems that rarely break down.

The Three Jobs Money Must Do

To understand why money matters, we have to understand what it does, not just for economists, but for you. Imagine trying to trade a sandwich for a haircut. Or a bus ride for two hours of babysitting. Without a common standard, every exchange would require haggling, approximating, or awkward math. Money fixes that.

In modern economies, money plays three essential roles:

• It’s a medium of exchange. It replaces bartering and allows people to trade goods and services with confidence. You don’t need your landlord to want your sourdough starter; you just need them to accept your payment.
• It’s a store of value. You can earn money today and spend it later. Without this function, you’d have to trade your labor or goods now, before they spoiled or expired.
• It’s a unit of account. You can compare prices and assign value across things that don’t naturally relate, like tacos, textbooks, and car insurance.

These may sound basic, but together they explain why money is a tool for building systems, not just buying snacks. Economists refer to these as the functions of money, and if money fails to perform any one of them, the entire system begins to break down.

Why Trade Needed Help

Before money existed, every transaction required coincidence, timing, and negotiation. If you wanted shoes and had eggs, you needed a shoemaker who wanted eggs right away, and who thought your dozen was worth one pair of boots. That kind of direct trade is called barter, and while it works in very small groups with limited needs, it collapses fast under complexity.

Economists refer to this as the double coincidence of wants, and it’s rare. Bartering breaks down when wants don’t match, when goods aren’t divisible, or when timing is off. You can’t trade perishable goods for long-term services. You can’t slice a couch in half to pay for half a haircut.

Money solves this. It acts as a neutral stand-in for value, making transactions flexible and scalable. It lets people trade asynchronously, across distances, and without needing to know or trust each other personally. It breaks open closed loops of barter and turns them into wide, open webs of exchange.

Once you see this, the purpose of money sharpens: It doesn’t just enable trade; it simplifies the transaction itself. It makes the economy faster, broader, and more resilient. Without it, systems shrink. With it, they expand.

You don’t need to memorize these terms. However, you need to understand that these functions explain why money matters and how it behaves in various financial decisions. A currency that fails at even one of these jobs loses its usefulness fast. If money can’t store value, people rush to spend it. If it can’t serve as a unit of account, prices make no sense. If it’s not accepted in exchange, it becomes trivia, not currency.

The Traits That Make Money Work

If the functions of money explain what it does, then its traits explain how it can do those things effectively.

First: Durability. Money has to last. If your paycheck dissolved in the rain or your coins rusted through your pockets, it wouldn’t make a reliable store of value. That’s one reason societies moved beyond salt and silk.

Second: Portability. Imagine carrying a cow to pay your taxes. Not ideal. Money needs to be easily transferable and convenient to exchange. Paper and digital forms consistently outperform livestock.

Third: Divisibility. You should be able to split money into smaller pieces without losing its function. This is why a dollar breaks into cents, and why barter systems ("I'll trade you five apples for one hammer") don’t scale well.

Fourth: Scarcity. If money were limitless, it wouldn’t hold value. Consider tulip bulbs in 17th-century Holland or hyperinflation in modern Venezuela. When supply explodes, value vanishes.

When something has all four of these traits, we trust it to behave like money, even if it’s just paper or pixels. Economists refer to these as the characteristics of money. You don’t need to memorize the label, but once you’ve seen them in action, you’ll spot why some systems work and others crumble.

Why It Matters Now

This might sound abstract, but it’s not academic fluff. It’s the foundation for everything else that’s coming: Interest, inflation, credit, investment, and debt. None of it makes emotional or intellectual sense without understanding what money is, and what it isn’t.

Think of this section as the platform you’ll stand on when you look out at the financial landscape. With it, you’ll see farther. Without it, everything just looks like math.

Summary

Money is more than paper—it's a social contract. To function, it must act as a

• medium of exchange
• store of value
• unit of account

But for that to work, money must be

• portable
• durable
• divisible
• scarce

This section explores how money evolved into the tool it is today and why we rely on it so deeply.

Exercises

1. What traits make your preferred form of payment feel trustworthy?
2. What happens to an economy when the public stops believing in its currency?
3. Match each function of money to a real-life scenario: buying coffee, comparing prices, saving for tuition.