Introduction to Finance

Purchasing power
is the amount of goods 
and services that can be purchased with a unit of money. Money can perform its function as 
a store of value only if its purchasing power is relatively stable over time. Under this condi-
tion, the spending decision is separated from the income decision. Once income is received, 
the holder of the income can choose to spend it or save it. If the decision is to save, then that 
money can be made available through the savings-investment process to those who may want 
to invest now. Purchasing power is reduced by 
infl ation
, which is a rise, or increase, in the 
prices of goods and services that is not off set by increases in their quality.
Any asset other than money can also serve as a store of value as long as that asset can 
be converted into money quickly and without signifi cant loss of value. We refer to this qual-
ity—the ease with which an asset can be exchanged for money or other assets—as 
liquidity
. 
Money is perfectly liquid since it is a generally accepted medium of exchange. Other assets, 
such as savings deposits held at depository institutions, approach the liquidity of money. The 
existence of such liquid assets reduces the need for holding money itself as a store of value.
Money also serves as a 
standard of value
, which means that prices and contracts for 
deferred payments are expressed in terms of the monetary unit. For example, in the United 
States, prices and debts are usually expressed in terms of dollars without stating whether the 
purchase will be cash or credit. Of course, if money is to perform its function as a standard 
of value, it is essential that the value of the monetary unit be relatively stable over time. For 
example, if one dollar can be used to purchase two ballpoint pens today but only one tomor-
row, such money would not be very eff ective as either a store of value or a standard of value.
While money is the fundamental measure of wealth, an individual’s net worth usually 
consists of more than just money.