The 5 Qualifications & 3 Roles of Money

dollar, money, cash, dough, criteria, true moneyQ: What Are the 5 Qualifications and 3 Roles of Money?

A: There are five qualifications a commodity must meet to qualify as money:

  1. 1. Scarcity: Things like gold and silver are scarce. Currency is not scarce, because the central bank can double the amount in circulation at any moment.
  2. 2. Durability: Gold, silver, and salt are durable, but cattle and seashells would not be. Paper and plastic currencies wear out over time, so they’re not really durable.
  3. 3. Portability: Gold and silver are easy to transport, as are dollars and diamonds. Real estate or livestock would be extremely difficult to transport.
  4. 4. Divisibility: Gold and silver are easily divisible without changing their essence. Although currency cannot be physically divided, governments have created smaller denominations to allow for divisibility.
  5. 5. Fungibility: Any two nickels are the same and can be interchanged. Precious metals are the same, as are individual shares of a stock. By contrast, a diamond is unique and must be priced individually. Thus, diamonds are not suitable as money.

 

There are also three fundamental roles a commodity must fill to be considered money:

  1. 1. The item must serve as a medium of exchange. You can trade your goods for currency and then hold on to that currency until you find something of equal value.
  2. 2. The item must serve as a store of value. A unit of money must be able to be saved between exchanges and maintain its value from the time it is gained to the time it is spent.
  3. 3. The item must be a unit of account. There must be a standard amount tied to the value of other goods. You can judge the relative value of an apple to a car by the amount of money it would take to purchase each.