Why do people readily accept intrinsically worthless pieces of paper money in exchange for valuable goods and services?

Answer 1

The purpose of paper money is really to provide for a medium of exchange. In simple terms (although it is actually quite complicated), the story works like this:


There are two types of people in the world, those that are young and those that are old. The young people can produce things but the old people are too old to work. The young people could barter for their necessities because they are producing but the old people can not. These old people need to be able to gain access to the necessary items to survive. Because they are no longer producing goods they need to provide something of value to the young person in order to obtain it. In order to do this, when the old person was young they exchanged some of the efforts they contributed towards production for a piece of paper that entitled them to use it in the future in order to obtain the goods necessary for survival.

Another need for money is that, suppose there are three people. Jim, Joe and Bob. Jim owns an apple farm, Joe owns a banana farm and Bob owns a Pear farm. Suppose then that Jim likes to eat bananas but Joe hates apples but loves Pears. Bob, however likes apples. In the absence of money, in order to get a banana, Jim would have to trade some apples with Bob to get pears. He would then be able to trade pears with Bob for some bananas. For Jim to know that he must trade for pears first in order to get bananas is complicated. It becomes even more complicated when there are millions of other goods available than just three of them. It would be much simpler if Bob can sell his apples to lots of different people and receive a peice of paper that he can use to buy his bananas and his pears (if he also likes pears) ot whatever else he might want.

Another need for money is the ability to easily determine somethings value. For example, if we bartered would we know how many bananas would be required to exchange for a can of coke or how many apples are needed in exchange for a gallon of gasoline? Probably not, because there would be far too many items with no base value.


Paper money has value only because we believe it has value. We believe it has value because in the scenario listed above something of value was exchanged for it.


In reality (and gold-standard advocates will probably disagree with me), gold has no more value than paper. We simply believe it does for for the same reason we treat paper money as having value. That is, Gold can be used as a medium of exchange.


The value of any medium of exchange is going to be based on its relative scarcity as long as it is universally recognized as a medium of exchange.