Question

Maria's parents told her that for the ten years prior to her high school graduation, they saved 200 dollar per month for her college education - 24,000 dollar (plus interest). Which function of money does this example best illustrate? Why?

Short answer

The example illustrates the 'store of value' function of money.

Step-by-step solution

Identify the Functions of Money

The primary functions of money are as a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. Review these functions to understand which one applies to saving money over time.

Analyze the Situation

Maria's parents saved $200 per month for ten years specifically for her education. This accumulation suggests that they were using money as a means to hold value over time.

Identify the Relevant Function

From the situation, the behavior of saving money for future use aligns with the 'store of value' function of money. This function allows money to be saved and retrieved in the future, retaining its value over time despite not being spent immediately.

Conclusion

Maria's parents' saving behavior best illustrates the 'store of value' function of money, as they held money to use in the future for her education.

Key concepts

Store of Value

Money acts as a store of value by allowing individuals to save or hoard wealth for future use. This function ensures that purchasing power is maintained over time, although it may be subject to inflation. The example of Maria's parents saving money for her college education is a perfect illustration. They put aside $200 each month not to spend it right away but to use it later to pay for college, banking on its ability to retain value until needed. In other words, they trusted that their savings would remain useful and valuable over the years. Hence, the store of value function encourages saving and planning for future financial needs.

Medium of Exchange

The medium of exchange function of money makes it possible for goods and services to be traded efficiently in the market. It simplifies transactions by eliminating the complex barter system, where finding a double coincidence of wants is tedious. Instead of Maria's parents needing to exchange another good or service for her education, they could simply use money they saved to pay for tuition. This ease of transferability and acceptability is fundamental to economic transactions. Money as a medium of exchange enables smoother, faster, and more reliable trading in everyday commerce.

Unit of Account

The unit of account function provides a common measure to express the value of goods, services, and transactions. It enables consumers and businesses to compare costs and determine whether they are getting fair value or making a loss. For instance, Maria's college fees can be measured and planned in thousands of dollars, a consistent standard that helps in budgeting and accounting for future educational expenses. This function simplifies trade by providing a uniform financial language, helping in financial planning and economic analysis.

Standard of Deferred Payment

Acting as a standard of deferred payment, money facilitates agreements and contracts that involve future payments. It sets a clear, agreed-upon method for settling debts or future transactions. For instance, Maria could decide to take a student loan, with a clear understanding that she will repay it in dollars over time. This aspect of money ensures that both parties in a contract understand the terms and the value of future payments, thereby providing legal and economic certainty. It underlines a key component of credit systems, allowing both consumers and businesses to plan and operate with foresight and assurance.