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Objectives
After studying this section you will be able to:
1. Describe the three uses
of money.
2. Explain the six characteristics of money.
3. Understand the sources
of money ’s value. | Section
Focus
Money serves as a
medium of
exchange, a unit of account,
and a store of value. Although
many objects have
served as
money in the past, the coins
and bills we use today meet
the needs of modern
society | Key Terms
money
medium of exchange
barter
unit of
account
store of value
currency
commodity
money
representative money
fiat
money | | | |
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1.
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Study the introduction to Ch 10
Section 1. Explain what you are expected to learn from this unit. Also, try to remember the
vocabulary words as you encounter them in the lessons that follow. You will be tested on these words
later
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Suppose you have just arrived at your
neighborhood store after playing
basketball
on a hot day. You grab a soda
and fish around in your jeans pockets for
some money. You find a
pen, keys, and a
chewing gum wrapper, but, unfortunately,
no money. Then you reach into your
jacket
pocket. Finally! —a crumpled dollar bill.
You hand the money to the clerk
and take a
long, cold drink.
Money is a part of our daily lives.
Without it, we
can ’t get the things we need
and want. That ’s not the whole story
of
money, however. In fact, money has functions and characteristics that you might
never have
thought about.
| The Three Uses of
Money
If you were
asked to define money, you
would probably think of the coins and bills
in your wallet or the
paychecks you receive
for your part-time job. Economists define
money in terms of its three
uses. For an
economist, money is anything that serves as
a medium of exchange, a unit of
account,
and a store of value.
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2.
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Which statement below is most
correct about the way Economists see money?
a. | Money has a singular
purpose | c. | Money has at least
three purposes | b. | Money is the only thing people can use to exchange goods and
services | d. | Money is always in the form of bills
and coins |
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Money as a
Medium of Exchange
A
medium of exchange is anything that is
used to determine value during the
exchange of
goods and services. Without
money, people acquire goods and services
through barter, or
the direct exchange of
one set of goods or services for another.
Barter is still used in many
parts of the
world, especially in traditional economies
in Asia, Africa, and Latin America. It
is
also sometimes used informally in the
United States. For example, a person might
agree to
help paint a neighbor’s house in
exchange for vegetables from the
neighbor’s
garden. In general, however, as an
economy becomes more
specialized,
bartering becomes too difficult and time consuming to be practical.
To
appreciate how much easier money
makes exchanges, suppose that money did
not exist, and that
you wanted to trade
your video cassette recorder (VCR) for an
audio CD player. You probably
would have
a great deal of trouble making the
exchange. First, you would need to
find
someone who wanted to both sell the
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model of CD player you want and
buy
your particular VCR. Second, this person
would need to agree that your VCR is
worth the
same as his or her CD player. As
you might guess, people in barter
economies spend a great deal
of time and
effort exchanging the goods they have for
the goods they need and want.
That’s why
barter generally works well only in small,
traditional economies.
Now
consider how much easier your
transaction would be if you used money as
a medium of exchange.
All you would have
to do is find someone who is willing to pay
you $100 for your VCR. Then you
could
use that money to buy a CD player from
someone else. The person selling you the
CD
player can use the $100 however he or
she wishes. By the same token, the person
who buys your
VCR can raise that money
however he or she wishes. Because money
makes exchanges so much
easier, people
have been using it for thousands of
years.
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3.
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Farmer Lopez has a horse that
needs new shoes. He goes to blacksmith Schneemann and gives him a pig to do the job. This is an
example of
a. | service for service
exchange | c. | money as a store
of value | b. | bartering | d. | goods for goods exchange |
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4.
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What is the main idea of the
reading above?
a. | Money makes the economy run
smoothly | c. | Money is the root
of all evil | b. | Money and barter are two different things | d. | Money can destroy an economy |
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Money as a
Unit of Account
In
addition to serving as a medium of
exchange, money serves as a unit of
account. In other
words, money provides a means for comparing the values of goods and services. For example, suppose
you see a jacket on sale for $30. You know this is a good price because you have checked the price of
the same or similar jackets in other stores. You can compare the cost of the jacket in this store
with the cost in other stores because the price is expressed
in the same way in every store in
the
United States? —in terms of dollars and
cents. Similarly, you would expect a movie in
the theater to cost about $7.00, a video rental about $3.50, and so forth.
. | Other countries
have their own forms of
money that serve as units of account. The Japanese quote prices in terms
of yen, the Russians in terms of rubles, Mexicans in terms of nuevo pesos, and so
forth | | |
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5.
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A Unit of Account allows people
to
a. | purchase products at lower
prices | c. | exchange
products | b. | compare products | d. | increase their wealth |
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6.
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In the United States we express
a Unit of Account in terms of
a. | the quality of the products we
buy | c. | international
currency | b. | dollars and cents | d. | the health and safety of
products |
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Money as a
Store of Value
Money
also serves as a store of value. This means that money keeps its value if you decide to hold
on to —or store —it instead of spending it. For example, when you sell your
VCR to purchase a CD player, you might not have a chance to purchase a CD player right away. In the
meantime, you can keep the money in your wallet or in a bank. The money will still be valuable and
will be recognized as a medium of exchange weeks or months from now when you go to buy the CD
player.
Money serves as a good store of value
with one important exception.
Sometimes
economies experience a period of rapid
inflation, or a general increase in
prices.
For example, suppose the United States
experiences 10 percent inflation during
a
particular year. If you sold your VCR at
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the beginning of that year for $100,
the
money you received would have 10
percent less value, or buying power, at the end of the
year. This is because the price
of the CD player would have increased by
10 percent during the
year, to $110. The
$100 you received at the beginning of the
year would no longer be enough to
buy the
CD player.
In short, when an economy experiences
inflation, money does not
function as well
as a store of value. You will read more
about the causes and effects of
inflation in
Chapter 13 | | |
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7.
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Farmer Frank has 100 pigs.
Those pigs have value. How would farmer Frank convert the value of the pigs into something he can put
in his pocket?
a. | Convert the 100 pigs into money by
selling them | c. | Write the value of
the pigs on a piece of paper and put the paper in his pocket | b. | Trade the 100 pigs to another farmer for some other
product such as cows | d. | There is no way to convert the value
of a pig into something you can put in your pocket |
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8.
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If you have $100. it means that
you can purchase $100 worth of goods and services. When the price of goods and services rises, it is
called inflation. What happens to your $100 during inflation?
a. | Its value rises with inflation
because things now cost more | c. | Its value declines with inflation because you can buy less goods and services
with your $100 | b. | Its value stays the same because money is not goods and
services | d. | Its value rises with inflation
because things now cost less |
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9.
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During a period of
inflation
a. | money functions the same as a store
of value | c. | money functions
better as a store of value | b. | money stays the same because prices stay the
same | d. | money functions less well as a store of
value |
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The Six
Characteristics
of Money
The coins and paper bills used as money
are called currency. In the past,
societies
have also used an astoundingly wide range
of other objects as currency. Cattle,
salt,
dried fish, furs, precious stones, gold, and
silver have all served as currency
at
various times in various places. So have
porpoise teeth, rice, wheat, shells,
tulip
bulbs, and olive oil. These items all
worked well in the societies in which they
were
used. None of them, however, would
function very well in our economy today.
Each lacks at least
one of the six characteristics that economists use to judge how well an item serves as currency.
These six characteristics are durability, portability,
divisibility, uniformity, limited supply,
and
acceptability. |
1 Durability
Objects used as money must withstand
the
physical wear and tear that comes with
being used over and over again. If money
wears
out or is easily destroyed, it cannot
be trusted to serve as a store of value.
Unlike wheat or
olive oil, coins last for
many years. In fact, some collectors have
ancient Roman coins that
are more than
2,000 years old. While our paper money
may not seem very durable, its rag
(cloth)
content helps $1 bills typically last at least
a year in circulation. When paper bills
wear
out, the United States government can
easily replace them. | | |
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10.
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What is
currency?
a. | gold and
silver | c. | the many objects that past societies
have used to trade | b. | coins and bills we can hold in our pockets | d. | all of these choices are forms of
currency |
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11.
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Which item below passes the
durability test for money?
a. | coins and vegetable
products | c. | news print paper
and coins | b. | coins and paper with cloth content | d. | money and power |
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12.
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Which of the following items is
NOT a characteristic that
economists use to judge how well an item serves as currency.
a. | portability | e. | sensibility | b. | divisibility | f. | acceptability | c. | durability | g. | uniformity | d. | limited supply |
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2
Portability
People
need to be able to take money with
them as they go about their daily business.
They also must
be able to easily transfer
money from one person to another when
they use money for purchases.
Paper money
and coins are very portable, or easily
carried, because they are small and
light.
3 Divisibility
To be useful, money
must be easily divided
into smaller denominations, or units of
value. When money is divisible,
people
only have to use as much of it as necessary
for any exchange. In the 16th and 17th
centuries, people actually used pieces of coins to pay exact amounts for their purchases.
Spanish
coins called doubloons had lines scored or etched on them so that they could be easily divided into
eight parts. Spanish coins, in fact, came to be called ? “pieces of eight.? ” Today, of
course, if you use a $20 bill to pay for a $5 lunch, the cashier will not rip your bill into four
pieces in order to make
change. That? ’s because American currency, like currencies around
the world, consists of various denominations? —$5 bills, $10 bills, and so
on. | 4
Uniformity
Any two
units of money must be
uniform? —that is, the same? —in terms of
what they will
buy. In other words, people
must be able to count and measure money
accurately.
Suppose
everything were priced in terms
of dried fish. One small dried fish might
buy an apple. One
large dried fish might
buy a sandwich. This method of pricing is
not a very accurate way of
establishing the
standard value of products because the size
of a dried fish can vary. Picture
the arguments people would have when trying to agree whether a fish was small or large. A dollar
bill, however, always buys $1 worth of goods. | | |
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13.
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The fact that you can carry
your money in your pocket when you go on vacation shows that money is
a. | uniform | c. | portable | b. | divisible | d. | sensible |
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14.
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Which statement is
true?
a. | Spanish money was devisable while
American money is not | c. | Neither Spanish
nor American money is or has been devisable | b. | Spanish money was devisable and so is American
money | d. | All money has the same
value |
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15.
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Which statement is
true?
a. | Individual units of money should
have the same value | c. | Individual units
of money from each country has the same value | b. | Individual units of money cannot have the same
value | d. | money has no
value |
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5 Limited
Supply
Suppose a
society uses certain pebbles as
money. These pebbles have only been
found on one beach. One
day, however,
someone finds an enormous supply of
similar pebbles on a different beach.
Now
anyone can scoop up these pebbles by the
handful. Since these pebbles are no longer in
limited supply, they are no longer useful
as currency.
In the United States, the Federal
Reserve
System controls the supply of money in
circulation. By its actions, the
Federal
Reserve is able to keep just the right
amount of money available. You’ll
read
more about how the Federal Reserve
monitors and adjusts the money supply in
Chapter
16. | 6
Acceptability
Finally, everyone in an economy must be
able to exchange the objects that serve
as
money for goods and services. When you
go to the store, why does the person behind
the
counter accept your money in exchange
for a carton of milk or a box of pencils?
After all,
money is just pieces of metal or
paper. Your money is accepted because the
owner of the store
can spend it elsewhere to
buy something he or she needs or wants.
In the United States, we
expect that other
people in the country will continue to
accept paper money and coins in
exchange
for our purchases. If people suddenly lost
confidence in our currency’s value,
they
would no longer be willing to sell goods
and services in return for dollars.
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16.
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The Acceptability of money
means
a. | it must be attractive and long
lasting | c. | people are not
willing to exchange if for goods and services | b. | money must be different from other goods and
services | d. | people are willing to exchange if
for goods and services |
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17.
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Your grandfather decides to
exchange all of his retirement money for gold. What would happen if someone discovered an unlimited
supply of gold in Alaska?
a. | Grandp’s retirement savings
would most likely be worthless | c. | Grandp’s retirement savings would decrease
slightly | b. | Grandp’s retirement savings would increase in
value | d. | Grandp’s retirement savings would not be
effected |
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18.
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Which government agency
controls the supply of money in circulation?
a. | The Federal Trade
Commission | c. | The Internal
Revenue Service | b. | The Federal Communication Commission | d. | The Federal Reserve Bank |
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19.
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You have $1,000 in savings.
What would happen to your $1,000 if the Federal Reserve Bank decided to increase the supply of money
in circulation?
a. | Your $1,000 would be worth less
| c. | Your $1,000 would be worth
more | b. | Your $1,000 would be worth about the same | d. | The value of money is not effected by the behavior of the Federal Reserve
Bank |
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 Sources of
Money’s Value
Think about the bills and coins in your
pocket. They are durable and
portable.
They are also easily divisible, uniform, in
limited supply, and accepted
throughout
the country. As convenient and practical as
they may be, however, bills and coins
have
very little value in and of themselves. What,
then, makes money valuable? The answer
is
that there are actually several possible
sources of money’s value, depending on
whether
the money is commodity, representative, or fiat money.
Commodity Money
A commodity is an object. Commodity money
consists of objects that have value in and of themselves and that are also used as
money.
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For example, salt, cattle, and precious
stones have been used in
various societies
as commodity money. These objects have
other uses as well. If not used as
money,
salt can preserve food and make it tastier.
Cattle can be slaughtered for their
meat,
and gems can be made into jewelry.
Tobacco, corn, and cotton all served as
commodity
money in the American
colonies.
As you can guess, commodity money
tends to lack several
of the characteristics
that make objects good sources of money.
For example, it is often not
portable,
durable, or divisible. That’s why
commodity money only works in
simple
economies. As the American colonies developed more complex economic systems,
tobacco and
other objects were no longer
universally accepted as money. The colonies
needed a more
convenient payment system.
They turned to representative money to
meet their
needs. | | |
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20.
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Oil is an example of
a. | representative
money | c. | commodity | b. | fiat money |
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21.
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Gold and silver certificates
are an examples of
a. | representative
money | c. | fiat
money | b. | commodity money |
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22.
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Federal Reserve Notes are an
example of
a. | fiat
money | c. | commodity
money | b. | representative money |
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23.
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Which type of money serves the
needs of the United States best?
a. | commodity
money | c. | representative
money | b. | fiat money | d. | no one form of money serves the needs of the United States
best |
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Representative Money
Representative money makes use of
objects
that have value because the holder can
exchange them for something else of
value.
For example, if your brother gives you an
IOU, the piece of paper itself is
worth
nothing. The promise that he will do all of
your chores for a month may be worth
quite
a lot, however. The piece of paper
simply represents his promise to you.
Early
representative money took the
form of paper receipts for gold and silver.
Gold or silver money
was heavy and thus
inconvenient for customers and merchants
to carry around. Each time someone
made
a transaction, the coins would have to be
weighed and tested for purity. People therefore
started to leave their gold in goldsmiths’ safes. Customers would carry paper ownership
receipts from the goldsmith to show how much gold they owned. After a while merchants began to accept
goldsmiths ’ receipts instead of the gold itself. In this way, the paper receipts became
an early form of paper money.
Colonists in the Massachusetts Bay
Colony first used
representative money in
the late 1600s when the Colony ’s treasurer
issued bills of
credit to lenders to help
finance King William ’s War. The bills of
credit showed
the exact amount that
colonists had loaned to the Massachusetts
government. Bill holders could
redeem the paper for specie, that is, gold and silver coins. |
Representative money was not without
its problems. During the American Revolution,
the Second Continental Congress
issued
representative money called Continentals to finance the war against England. Unfortunately,
few people were able to redeem these early paper currencies for specie because the federal
government
had no power to collect taxes. Until
the Constitution replaced the Articles
of
Confederation in 1789, the federal government depended on the states ’ voluntary
contributions to fill the treasury. As a result, the federal treasury held very little
gold or
silver. Continentals became worthless
because people came to believe that they would not be able
to redeem their bills for gold and silver coins. People even began to use the phrase
“not worth a Continental ” to refer to something useless.
Later, the United
States government issued representative money in the form of silver and gold certificates. These
certificates were “backed ” by gold or silver. In other
words,
holders of such certificates could
redeem them for gold or silver at a local
bank. The United
States government thus
had to keep vast supplies of gold and silver
on hand to be able to
convert all paper
dollars to gold if the demand arose. Some
silver certificates circulated
until 1971, but
for the most part, the government stopped
converting paper money into silver or
gold
in the 1930s. | | |
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24.
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What does the above reading
suggest about the value of representative money?
a. | Representative money has always been
a stable source of value | c. | Representative money has no value apart from the gold and silver that it
represents | b. | When the government raises taxes it increases the value of Representative
Money backed by gold and silver | d. | Representative money gets its value from the confidence people have that they
will be able to redeem their money for goods and
services |
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25.
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During the Civil War the
Confederate States issued representative money called “Confederate Dollars.” What does
the reading above suggest about the value of Confederate Dollars?
a. | It is highly
valuable | c. | It had the same
value as Union dollars | b. | It is worthless | d. | It could only be used inside the Confederate States to purchase goods and
services. |
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Fiat
Money
If you examine
a dollar bill, you will see
George Washington’s picture on one side,
and on the other
side the words, “This note
is legal tender for all debts, public and private. ” In
essence, these words mean that
our money is valuable because our government says it is.
| United States money today is fiat money.
A fiat is an order or decree.
Fiat money, also
called
“legal tender,” has value because the government has decreed that it is an acceptable
means to pay debts. It remains in
limited supply, and therefore valuable,
because the Federal
Reserve controls its
supply. This control of the money supply is
essential for a fiat system to
work. | | |
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26.
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What does the reading say about
“Fiat Money” ?
a. | Fiat money has value because the
government says it has value | c. | Fiat money is worthless | b. | Fiat money has value because it is backed by gold or
silver | d. | The value of Fiat Money is always the
same. |
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a. | currency | f. | service money | b. | medium of exchange | g. | unit of account | c. | fiat money | h. | barter | d. | store of value | i. | money | e. | commodity money | j. | representative money |
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27.
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the direct exchange of one
set of goods or services for another
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28.
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a means for comparing the
values of goods and services
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29.
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objects that have value
because the holder can exchange them for something else of value
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30.
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coins and paper bills used as
money
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31.
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something that keeps its value
if it is stored rather than used
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32.
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money that has value because
the government has ordered that it is an acceptable means to pay debts
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33.
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objects that have value in
themselves and that are also used as money
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34.
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anything that serves as a
medium of exchange, a unit of account, and a store of value
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35.
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anything that is used to
determine value during the exchange of goods and services
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