Trade makes people better off, but trading directly, goods for goods, is clumsy. A baker who wants shoes has to find a shoemaker who wants bread. Money solves that problem.
Key idea
Money is anything widely accepted in payment. It does three jobs: a medium of exchange (you trade it for goods and services), a unit of account (prices and values are measured in it) and a store of value (it holds buying power until you spend it).
Why it works
Under barter, every trade needs a "double coincidence of wants," and every pair of goods needs its own price: with 100 goods there would be $\dfrac{100 \times 99}{2} = 4{,}950$ exchange rates to keep track of. With money, each good needs one price in dollars, and you can sell your labor for money and spend it on anything, now or later. Money need not be backed by gold: today's dollars are fiat money, valuable because people accept them in trade and the government accepts them for taxes.
A worked example
Worked example: Is it money?
Which are money: (a) a \$20 bill, (b) a checking account balance, (c) a credit card, (d) shares of stock?
- (a) Yes: currency is accepted in payment.
- (b) Yes: you can spend it directly with a debit card or check.
- (c) No: a credit card is a way to borrow. The purchase is paid with the card company's money, and you repay that loan with money later.
- (d) No: stocks can be sold for money, but they are not accepted in payment.
Answer: (a) and (b)
Common mistake
Calling a credit card money, or thinking money must be backed by gold to work. A credit card creates a loan; a dollar works because people trust it will be accepted. Check: can you hand it over to settle a debt for good? A credit card swipe leaves you owing money.