What is money, and what do banks and financial markets do for the economy?
The functions and characteristics of money, and the role of money and financial markets, including banks, in allowing saving, borrowing and investment.
An OCR J205 answer on the functions and characteristics of money and the role of money and financial markets, including how banks channel saving into borrowing and investment.
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What this dot point is asking
OCR wants you to explain the functions and characteristics of money, and the role of money and financial markets, including banks, in letting people save, borrow and invest. This links the microeconomics component to the financial system studied further in Component 02.
What money does: the four functions
The four functions are:
- Medium of exchange. Money is accepted in return for goods and services, removing the need for barter (directly swapping goods), which needs a "double coincidence of wants".
- Store of value. Money holds its value over time, so people can save now and spend later (as long as inflation is low).
- Unit of account. Money provides a common measure of value, so prices can be compared (a phone at versus a bike at ).
- Standard of deferred payment. Money lets debts be set and repaid over time, which makes borrowing and lending possible.
The characteristics of good money
For money to perform its functions well, it should be:
- Durable (lasts without wearing out),
- Portable (easy to carry),
- Divisible (can be split into smaller units for small purchases),
- Acceptable (widely trusted and used),
- Scarce (limited in supply, so it keeps its value),
- Hard to forge (difficult to copy).
Modern money (notes, coins and, increasingly, digital balances) is designed around these characteristics.
Financial markets and banks
Banks and financial markets perform several jobs for the economy:
- Channelling savings into borrowing. They match people with spare funds (savers) to people who need funds (borrowers), including firms wanting to invest.
- Providing a payments system. Cards, transfers and online payments let money move quickly and safely.
- Spreading risk and time. They let households borrow to buy homes or smooth spending, and let firms fund investment before it pays off.
Why this matters for growth
When banks lend savings to firms for investment in new machines, technology and buildings, the economy's productive capacity grows. So a well-functioning financial system supports higher productivity and economic growth, while a banking crisis (when lending dries up) can cause a recession. This is why the financial system is so closely watched and regulated.
Try this
Q1. State the four functions of money. [2 marks]
- Cue. Medium of exchange, store of value, unit of account, standard of deferred payment.
Q2. Explain one way banks help firms grow. [3 marks]
- Cue. Banks lend savers' deposits to firms, which use the loans to invest in equipment that raises output and productivity.
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR J205/01 20184 marksState two functions of money and briefly explain one of them.Show worked answer →
A 4 mark question: marks for naming functions and one developed explanation.
The four functions of money are a medium of exchange, a store of value, a unit of account, and a standard of deferred payment. Two of these earn the naming marks.
Explaining one, for example medium of exchange: money is widely accepted in return for goods and services, so it removes the need for barter (swapping goods directly), where both parties must want what the other has. Markers reward two correct functions plus a clear explanation of one.
OCR J205/01 20216 marksExplain how banks and financial markets help the economy by channelling savings into investment.Show worked answer →
A 6 mark question on the role of financial intermediation.
Savers deposit money in banks rather than spending it. Banks then lend that money to borrowers, including firms that want to invest in new equipment and households buying homes. Banks act as intermediaries, matching those with spare funds to those who need them, and charge interest.
This helps the economy because firms can fund investment that raises productivity and growth, and households can spread spending over time. Markers reward the chain from saving, to banks lending, to firms investing, and the resulting benefit to the economy.
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Sources & how we know this
- OCR GCSE (9-1) Economics J205 specification — OCR (2017)