Economics · Lesson 16

Money, value of money & inflation

JAMBWAECNECO

What the syllabus asks

JAMB: Money and inflation: types, characteristics and functions of money; demand for and supply of money; quantity theory of money (Fisher’s equation); value of money and price level; inflation and deflation: types, measurement, effects and control

WAEC: Money: barter and its problems; meaning, functions, characteristics and types of money; demand for and supply of money; value of money and the price level; quantity theory of money; inflation (meaning, types, causes, effects, control); deflation (causes, effects, control)

NECO: Money: barter and its problems; meaning, functions, characteristics and types of money; demand for and supply of money; value of money and the price level; quantity theory of money; inflation (meaning, types, causes, effects, control); deflation (causes, effects, control)

What you will learn

Explain barter and its problems.
State and explain the functions, characteristics and types of money.
Explain the motives for demanding money and the components of the money supply.
Use the quantity theory (MV = PT) to explain the value of money.
Measure inflation using a price index and distinguish real from money values.
Explain the types, causes, effects and control of inflation and deflation.

Key points

Barter needs a double coincidence of wants and lacks a measure of value.
Money: anything generally acceptable in payment; functions: medium of exchange, unit of account, store of value, standard of deferred payment.
Good money: acceptable, portable, durable, divisible, homogeneous, scarce, stable.
Types: commodity, token, fiat/legal tender, bank money, near money; naira introduced 1 January 1973.
Keynes: transactions and precautionary motives depend on income; speculative on interest rate.
MV = PT; with V and T constant, P varies directly with M; value of money = 1 ÷ P.
Inflation is a persistent general price rise, measured by the CPI (compiled by the NBS).
Causes: demand-pull, cost-push, imported, structural.
Inflation hurts fixed-income earners and creditors, helps debtors; controlled by tight monetary and fiscal policy.
Deflation: falling prices, rising unemployment; cured by expansionary policy.

Start here: Barter and its problems

Imagine a yam farmer in Benue who wants a pair of shoes. Without money, he must find a shoemaker who wants yams, at the same time, and agree how many yams one pair of shoes is worth. This is trade by barter.

Barter is the direct exchange of goods and services for other goods and services without the use of money.

Problems (disadvantages) of barter

Double coincidence of wants: each party must want what the other has. This is rare and wastes time.
No common measure of value: how many tubers of yam equal one goat? Every pair of goods needs its own exchange ratio.
Indivisibility: a cow cannot be divided to buy a small item without destroying its value.
Difficulty of storing wealth: many goods are perishable (tomatoes, fish) or bulky.
No standard for deferred payment: borrowing and lending are difficult because future repayment in goods may differ in quality.
Limits specialisation: people produce for themselves because exchange is so hard.

Worked example 16.1

In a barter economy with 5 goods, how many exchange ratios are needed if every good is traded against every other? How many prices are needed with money?

Pairs of goods = n(n − 1) ÷ 2 = 5 × 4 ÷ 2 = 10 ratios.
With money, each good has one price: 5 prices.
For 100 goods: 100 × 99 ÷ 2 = 4,950 ratios versus 100 prices.

10 ratios vs 5 prices

⚠️ Common mistake: writing "double coincidence of want" as the only problem. WAEC essays expect at least four problems, each explained.

Try it yourself. Which problem of barter does a perishable good like fresh fish illustrate?

Show solution

Difficulty of storing value.

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Practice questions

1. Barter suffers mainly from

the need for a double coincidence of wants
too much money
inflation
high interest rates

Show answer

A: the need for a double coincidence of wants
Each trader must want what the other has.

2. When money is used to compare the values of goods, it serves as a

store of value
medium of exchange
standard of deferred payment
unit of account

Show answer

D: unit of account
Measure of value.

3. Money used to settle debts in future acts as a

medium of exchange
commodity
standard of deferred payment
unit of account

Show answer

C: standard of deferred payment
Loans are fixed in money terms.

4. Which is NOT a quality of good money?

Divisibility
Perishability
Portability
Durability

Show answer

B: Perishability
Good money must be durable.

5. Money that must be accepted by law in settlement of debts is

legal tender
near money
commodity money
bank money

Show answer

A: legal tender
The naira is legal tender in Nigeria.

Key words

Barter: Direct exchange of goods and services for other goods and services without money.
Double coincidence of wants: Situation where each party has what the other wants and wants what the other has.
Money: Anything generally acceptable as a means of payment for goods and services and settlement of debts.
Legal tender: Money that must by law be accepted in payment of debts.
Fiat money: Money that has value because the government declares it legal tender, not because of its material.
Fiduciary issue: Currency issued without backing by gold or foreign reserves.
Near money (quasi-money): Assets easily converted into money, e.g. savings and time deposits, treasury bills.
Liquidity preference: The desire to hold wealth in the form of money (Keynes).
Velocity of circulation: Average number of times a unit of money changes hands in a period.
Value of money: Its purchasing power; the quantity of goods and services a unit of money can buy.
Inflation: A persistent and general rise in the price level, i.e. a fall in the value of money.
Hyperinflation: Extremely rapid inflation in which money loses value very quickly.

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