But, as communities and economies grow, so this process of barter will become increasingly complicated and inefficient.  So people will seek out ways of making barter and exchange more efficient (less time and effort wasting).  They will start to develop "accounts owing" and I.O.Us. ("bills of exchange").  And they will use these to signify their valuations of the trades.  Money, by other names, is invented to assist the process of exchange, and make it more efficient.  And more flexible and responsive to changing tastes and preferences, and changing techniques, possibilities and opportunities.  Essentially, money comes to represent all other goods and services than the one we are currently bargaining about in our particular trades.  It becomes the nummary - the measure of things.  Money naturally emerges as a characteristic feature of economies.  But it is not fundamental to the existence or behaviour of an economy. The emergence of money - as the trusted medium of exchange to simplify and expediate exchange of goods and services (including labour) - makes the organisation of exchange very much simpler. The fact  that most societies use money (even if they are centrally  planned) as tokens of exchange is testament to the fact that money makes economic life far easier. If it did not exist already, we would need to invent it.

So, the prices of things, measured in money, are the social values of things as they are exchanged or traded in our communities.  You may well disagree with these social valuations, and think them inhumane, or worse.  You may choose to distance yourself from the rest of society by denying or contesting the rest of society's values.  But you cannot hope to change these social values sensibly without understanding how these values come to be generated and expressed as they do.  And this is what economics seeks to explain.  You can protest and force people to change their ways, habits and values - but if you do, you will generate a series of related and consequential changes throughout the system.

But, to be useful, such money has to be trustworthy - we need to be able to rely on it being worth what we thought it was in terms of the goods and services it is supposed to represent.  What makes it trustworthy?

• it should be relatively rare and definitely finite in supply - if there is too much of it relative to the goods and services it is supposed to represent, it will become worthless; if it is something which can be found on the ground or grown or made or added to, it will become worthless.  Too much money, relative to the goods and services whose exchange the money funds, leads to inflation - the value of money falls in terms of the goods and services it can buy;
• it should be inimitable - non counterfeitable - if people can make passable copies of the unit of money, then they can become rich (temporarily) while the rest of the community loses faith in its money unit.
• it should be permanent - not subject to decay or deterioration or shaving.

Trustworthy money allows our community to grow and develop according to its own wishes and inventiveness.  But it also opens up the possibility of crisis and collapse of the economy, if people lose their faith in it, or if there is not enough of it about, or if it accumulates in particular concentrations amongst a few rather than the many.  In this sense, it is a lot like the oxygen which supports life as we know it.  If the planet accumulates too much oxygen, it would spontaneously combust - raging inflation.  If the planet has too little oxygen, it will asphyxiate - catastrophic depression.  If oxygen is accumulated in too concentrated a fashion, then life around the concentration will atrophy - eutrophication of rivers.  Inequitable distributions of money (which represent incomes and wealth), or ill-fitted (antipathetic rather than sympathetic) concentrations of income and wealth, can be expected to lead to eutrophication of our economies - algal blooms blighting the rest of the surrounding ecology (economy).

So, although money is not fundamental to the basic trading and exchange of an economy, it does, once it has emerged, alter the way in which economies behave. It alters what economies can do, and alters the conditions in which they will be stable.  Money allows economies to diversify and expand, but it also opens up possibilities of collapse and fragmentation.  It makes our economic systems more complex.

However, the fundamental economics of money is simple.  The total stock of money in any economy (M) is necessarily related to the social valuations of all the goods and services being exchanged in the economy, which can be represented as a (large) collection of prices (P) times quantities of goods and services exchanged (Q).

M = P * Q

If there is too much money relative to the (finite and limited) quantities of goods and services people are willing to make and consume, what happens?  P (prices) must increase - we get inflation.  If there is too little money available for trade, then either prices must fall, or quantities must fall - we get depressions (and depressed).

Actually, of course, we use each unit of money (each £ coin) more than once during most reasonable production and consumption periods we might think of - a year, say.  The quantities we are talking about here are flows, not stocks.  They happen as numbers or something per year or per quarter or per week. Money, however, is a stock - it just is something - it is either there or it is not.  It just gets passed around.  The more frequently it is passed around, the larger the number of transactions (P*Q) any particular unit of the money stock can finance, or lubricate, or stand for.  The frequency of circulation, the number of time each unit of money is passed on, the rate of flow of the money stock through the economy, is known in economics as the "velocity of circulation" (v).  So, our complete equation for money now becomes:

M * v = P * Q,  which is an identity - it has to hold, by definition and by operation. In fact, this is the only way we can actually measure the velocity ofcirculation (v).  Whatever happens on one side of this equation must be balanced by equivalent happenings on the other side.  If this equation breaks down, then so, too, does our money system - the money we have been using becomes worthless.  If the money system exists and works, then this equation holds.  If not, then this equation is meaningless.  It is this equation which gives money its identity.

And this, the Fisher (or Quantity) equation of Exchange, will do for now.  We will come back to this important relationship when we turn to macroeconomics, in section 3e of this course.  For the present, notice that v tends to be relatively constant, depending on the habits and social conventions about the frequency with which we settle debts, and that real income or output (Q) tends to change more slowly than prices (P).  So, if we suddnely increase M, the money supply, then we are very likely to get inflation - an increase in P.  On the other hand, real growth - an increase in Q - requires an increase in the money supply, and also typically requires an increase in some prices to act as an incentive to produce more, and be more economical with scarce resources.
 

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