Summary
Highlights
Money serves three primary functions: as a medium of exchange, a unit of account, and a store of value. A medium of exchange allows for easy transactions, replacing barter. A unit of account provides a common measure for pricing goods and services. A store of value enables individuals to save purchasing power over time.
Money is classified into M0, M1, and M2. M0 includes currency and coins held by the public. M1, considered the total money supply, includes M0 plus checkable deposits and traveler's checks. M2 includes all of M1 plus 'near monies' like savings accounts, money market deposit accounts, and small-time deposits (under $100,000), which can be quickly converted to M1.
The money supply is no longer backed by gold. Instead, paper money and coins are considered debt of the government and the Federal Reserve, while checkable deposits are liabilities of banks. The Fed is the primary creator of money.
The value of money is determined by its acceptability, scarcity, and status as legal tender by Fiat (government decree). People accept money because it's widely recognized for payments, it's scarce, and the government officially mandates it as currency.
The value of the dollar is inversely related to the price level (1 divided by the price level). Inflation reduces the value of money over time, meaning a dollar today buys less than it did in the past and will buy less in the future.