You are Forced to Follow

Suppose the money in an economy changed overnight from green pieces of paper to purple pieces of paper, as we fancifully suggested at the beginning of this chapter. Everyone now works for and accepts the new purple currency. It would be foolish for you to work and accept green paper because no one would give you goods or services in exchange. Instead, you demand to be paid in purple paper because that is what you now need to buy goods and services. Of course, we do not often observe these switches across colors of paper within an economy. People get used to one type of currency, and it is difficult to change everyone’s behavior at once. Still, Europe did, in effect, switch from green pieces of paper to purple pieces of paper. Sure enough, no one in Europe these days is willing to accept French francs, Portuguese escudos, or Finnish marks. These are the old pieces of paper. Now people will accept only the new pieces of paper. That conversion was not truly instantaneous. Prior to the changeover to the euro, there was a switch to a dual unit of account: French bank statements in 2001 gave balances in both French francs and euros, for example. Even now, years after the changeover, bills in Europe often still appear in both the old local currency and euros. It was also possible to use the euro as a store of value before the changeover because banks started establishing accounts in euros. Even though fiat money issued by the government is, in the end, just pieces of colored paper, it typically does have one particular property that stems from the power of the state. The US government states that it will accept dollars in settlement of government debts—most importantly, tax bills. The government also states that dollars can be used in settlement of private debts. Dollars are legal tender. [2] The Functions of Money Thus far, we have thought about money in terms of its characteristics. We can also think about what makes a good or bad money in terms of the functions that it serves. Medium of Exchange If you walk into an electronics store and see a camera with a price tag of $500, the store is making an offer to you and other customers: if you hand over ten $50 bills, you can have the camera in exchange. Money serves as a medium of exchange. There are other ways to purchase a camera rather than cash. You could write a check, for example, or use a debit card (a card that immediately deducts the $500 from your bank account and pays it into the store’s account). The fact that there are different ways of paying for something is a clue that there is, in fact, no single thing that we can call money. Money is anything that does what money does. Interestingly, one common form of purchase does not involve money at all. If you use a credit card to buy a camera, you do not pay at all at the time of purchase, so no money—by any definition—changes hands. In this case, you receive the camera in exchange for a promise to pay for the camera later. It is only when that promise to pay is fulfilled that you hand over the money for the purchase.