Why does money have value? This post is all about this and more.
Before we get into that though, we can all agree that money has value. This is the reason why your net worth is determined by the amount of money you own after paying off everything you owe whether this comes down to the wad of bills in your wallet or your account balance.
Further, without any money to spend, you can’t get much done no matter how cheap it is, right? Unless someone decides to give it for free.
Want insight on why else you feel the need to have money besides the motive to pay for things you need? Check out this post on the existence of money.
Now that we are on the same page about money being valuable, what is it that makes it valuable? We will explore this and also look at the characteristics that make it valuable.
Further, we will discuss the factors that determine the value of money as well as FAQs related to the topic. Let’s get started!
Why Does Money Have Value?
Money has value because of mutual belief in its value. Because of this belief, the government limits the supply of money which increases its demand. As a valuable item, money is used to store value.
Discussed below are reasons why money is considered valuable.
1. There’s a Mutual Belief in Its Value
This means that as long as many people believe in the value of money, then money will retain its value. Because, after all, those pieces of paper in your pocket are just pieces of paper. So we can say that money works on a belief system.
But it is unlikely that we will see the collapse of this belief system soon. There are currently too many people holding cash of different values, and neither would be okay to let this system fail because nobody wants to lose money
2. It is a medium of Exchange
Goods and services of value can be paid for using money. The higher the value of the item or service, the more money is required to exchange it.
3. It Is a Store of Value
Let’s say you work today and earn $300. It will still have that value if you hold on to that money until tomorrow or a week later and that’s why people save money.
It is an effective way of storing value, unlike barter trade, where goods lose value quickly, especially if they are perishable.
As a store of value, money can be saved for retirement and other long-term goals. Over time, however, inflation can slowly reduce the value of the $300.
4. It is a unit of Account
We can use the cost of an item or service to measure its value. Typically, if it costs more money, then it is more valuable. For example, a full body massage will cost more value in money than a pedicure costs.
5. Money Has a Limited Supply
Governments all over the world keep this in check very closely. This is how they maintain the faith that people have in money. By maintaining a limited supply, they increase the demand for it and therefore increase its value. This also reduces inflation.
The Characteristics of Money that Give it Value?
Here are six characteristics of money that make it valuable in today’s world.
- Its durability. Money is made of material that makes it lasts for a long without losing value. Check out the process of making money.
- Its portability. Nowadays, people place importance on being able to carry around items that they hold valuable. And what better way to carry around value than carrying money?
- Its divisibility. You can easily split it into many denominations without losing its value.
- Its stability. The value of money does not change over a long period. This makes it particularly important as a measure of value when conducting trade.
- Its general acceptability. More people generally have faith in the system of money as a measure of value. This, combined with governments declaring money as legal tender, means that money has value as long as people continue to believe that it does.
- Its uniformity. Denominations of a currency are usually the same shape and color. This similarity makes them have the same value. For example, you can rely on $100 bills to remain $100 in value.
Factors that Determine the Value of Money
When it comes to the value of money, demand, and supply as explained earlier come into play. This consequently affects our ability to pay for goods and services, invest, save, and plan for the future.
At the fundamental level, however, several factors determine whether the value of money goes up, stays the same, or goes down.
1. Interest Rates
The interest rate is simply the fee you pay for borrowing money. For the borrowers, low-interest rates are favorable because they make it possible for more people to access credit.
The case is different when it comes to a country’s currency. Higher interest rates may carry a number of disadvantages for individual people but it also tends to attract foreign investment.
This consequently increases both the value and the demand for that country’s currency.
2. Currency Inflow vs Currency Outflow
Whether it is through the purchase of goods and services or direct investments, increased foreign currency inflow increases the value of a country’s currency.
Consequently, if more money is going out, the value of money in a particular country goes down.
3. The Supply of Money
As mentioned earlier, money has value because its supply is limited. That said, an increased supply of money reduces its value. How? When there’s more money in the hands of consumers, the tendency to spend is stimulated, increasing the demand for available goods.
This leads to an increase in prices yet the quantity and quality of goods remain the same, this means that the value of money reflected by its purchasing power has declined.
Inflation reduces the purchasing power of money as the cost of local goods increases. A high rate of inflation, therefore, reduces the value of money.
There are several causes of inflation including an increased supply of money as stated above. Others include higher demand and low supply of certain commodities and increased prices of goods due to higher cost of production.
The Value of Money in Life
The value of money in life is determined by its ability to help us live a better life. At the very basic level, money helps you to access the basic needs of life including food, clothing, shelter, healthcare, education, and sanitation.
Beyond the basics, money helps you thrive by eliminating unnecessary struggles and creating an environment that helps you grow financially, intellectually, and socially. Simply put, money provides:
- More options in life eg careers, how and where you want to live, and the things you want to do.
- The freedom to do what you want
- Financial security
- Opportunities to create as many life experiences as you want
- A means to take care of the needs of your family
- Opportunities to give back through charities and other worthy causes
Interesting Read: What is the Lowest Value of Paper Money?
Why Does Money Have Time Value?: FAQs
1. What is the Value of Money in Economics
The value of money in economics lies in the number of commodities that a unit of money can be exchanged for. That said, an increase in prices reduces the number of goods that a unit of money buys, meaning that the money has depreciated in value.
In contrast, a reduction in prices increases the number of goods that can be purchased, which translates to a higher value of money.
2. When Does Money Lose Value?
Money loses value when its value goes down in terms of its exchange rate in comparison to other currencies. This can happen due to an increased rate of inflation, political unrest, interest rate imbalance, and risk aversion.
3. When Is Money Considered More Valuable?
Money is considered valuable when its demand is high and its supply is relatively low.
4. How Do You Increase the Value of Currency?
Increased currency value can be achieved through increasing interest rates, reducing the rate of inflation, increasing the inflow of foreign currency, and limiting the supply of money.
5. What is the Time Value of Money?
The time value of money rides on the concept that a unit of money earned earlier is better than the same earned in the future. This is because money earned today can be invested to gain a return.
Also, due to inflation, the purchasing power of money may reduce, which makes today a better time to buy something than tomorrow. The time value of money is what inspires investments and early planning for retirement
In conclusion, we can say that money has value because we as a civilization agree that it does. As long as people believe that they can continue to exchange money for goods and services, money will continue to be valuable.
The government has its role in controlling inflation and ensuring that its currency stays valuable and we have outlined the factors that are at play. The faith in this system makes money the medium of exchange that it is today.
Finally, if the time value of money has taught us anything, it is better to make some money, invest, or buy something today because you never know what tomorrow holds in terms of money value.
As usual, we look forward to your comments! Feel free to put them down in the comment section below.
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I’m Swati, a mom, a personal finance enthusiast, and the owner of TheBlissfulBudget. My work has been featured in major publications including Fox 10, Credit Cards, Cheapism, How to Fire, Databox & Referral Rock.
I help busy budgeters like you save and make money by utilizing simple yet effective methods that can create wonders.
My Mantra: You are entitled to live the life you desire, and financial bliss should be simple to obtain–check out my blog for helpful tips on acquiring wealth easily.