Definition and Types of money

Go with me to the town of Ceelo, where Margie the cake baker is busy baking cupcakes in her own kitchen today, while Mike the mechanic works on her minivan in the driveway.

In the town of Ceelo, we often hear people using terms like money and wealth interchangeably. When people talk about Margie the cake baker and what a nice house she has, they often say, 'Margie has a lot of money.' However, there's an important distinction between money and wealth. Although wealth could mean stocks, bonds, real estate, or gold, money is something far simpler. In economics,money is anything that is widely accepted in exchange for goods and services.

precious metal and promised to exchange their currency for the metal on demand.  In other words, if you had a hundred dollar bill, you could walk into the U.S. Mint and exchange your paper for a hundred dollars' worth of gold.  Gold was a real thing with real value; the paper money had value only because it was redeemable for gold.

Finally, we get to fiat money (the stuff in your wallet), which is money because the government says it is. It is not backed by gold or any other substance of real value. It has no real use or value other than its value as a form of currency.  And its value is thus set by the market forces of supply and demand, just like everything else.  As long as people want dollars, they will have value.  If everyone in the world suddenly decided tomorrow that dollars are worthless... well, then they'd be worthless.  As you can see, money offers consumers and businesses some very basic and practical benefits. Money was invented as an alternative to bartering. The major benefit of money is that it increases the efficiency of an economy by reducing transactions costs. When people can use money instead of bartering, this leads to more specialization and better division of labor within the economy.

In an economy with money, Margie and Mike can specialize in what they do best instead of what they can use to exchange with other people. Margie can bake cakes instead of being a farmer, and Mike can repair cars, which he's really good at, instead of raising cattle.

Why does this really matter? Because an economy with more specialization and division of labor trades more often, produces more, and enjoys greater economic output.