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EXCHANGE RATE MECHANISM: The system used to link the euro to the currencies of European Union member nations that do not immediately participate in the use of the euro. Linkages with these non-participating European Union member nations is voluntary, but designed to ease their transition into full-blown use of the euro.

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STANDARD OF DEFERRED PAYMENT:

The money function in which money is used as a standard benchmark for specifying future payments for current purchases, that is, buying now and paying later. This function may seem obscure, but it is a direct result of the store of value and unit of account functions. This is one of four basic functions of money. The other three are medium of exchange, unit of account, and store of value.
Using money as a standard of deferred payments is a direct consequence of the unit of account and store of value functions of money. If money is the standard for current prices, then money is also the standard for future payments based on these prices. But, for money to function as a DEFERRED payment standard, it must retain value, it must also store value.

Buy Now, Pay Later

While many market transactions are almost instantaneous, a good is exchanged for money at approximately the same time. When Duncan Thurly buys a hot fudge sundae, he hands the ice cream vendor two, slightly wrinkled one-dollar bills as the vendor hands him a freshly prepared hot fudge sundae. The good goes from seller to buyer as the money goes from buyer to seller.

However, a number of transactions involve deferred payments--buy now, pay later. The good goes from seller to buyer today, but the money goes from buyer to seller tomorrow.

A common example of a deferred payment is that associated with buying a car, especially paying off a car loan. Duncan can get a loan to buy a car today, then pay off the loan with payments deferred into the future. In the same way that an immediate payment is stated in terms of the monetary unit, so too is any deferred payment.

For example, Duncan can buy a $10,000 car by making one immediate payment of $10,000, or one or more deferred payments that total (at least) $10,000. Whether immediate or deferred, the payments are based on the price of the car, which is stated in the monetary unit of dollars.

Inflation and Interest

Deferred payments depend in part on price and the unit of account function of money, and in part on how well money stores value. This means that deferred payments depend on interest rates and inflation. In the preceding car-buying example, Duncan Thurly is unlikely to purchase a car with deferred payments that total ONLY $10,000.

Suppose, for example, that Duncan plans to make one deferred payment a year after purchasing his $10,000 car. If the going interest rate is 10 percent, then Duncan's deferred payment is something like $11,000. The extra $1,000 (10 percent of the $10,000 price) is needed to compensate the seller for the interest lost when waiting a year to get paid.

This 10 percent interest adjustment of the deferred payment is also dependent on inflation. A positive inflation rate (anything greater than zero) means that the interest rate is greater than 10 percent. That is, the seller also needs to be compensated for the loss of value resulting from higher prices. Alternatively, a negative inflation rate (anything less than zero) means that the interest rate is less than 10 percent.

A 5 percent annual inflation rate means that the deferred payment for this $10,000 car is approximately $11,500. This amount is the combination of the $10,000 purchase price, the $1,000 interest, and an extra $500 to adjust for the declining value of the money resulting from higher prices.

The Other Three Functions

The standard of deferred payment function is one of four money functions. Three other functions are also worth noting.
  • Medium of Exchange: This function means that money is accepted throughout the economy as payment for goods and services. Buyers acquire goods by giving up money. Sellers receive money when parting with their goods. This is, without question, the most important function of money. This is the function that makes money MONEY.

  • Unit of Account: This function means that money is used to designate the prices of goods and services. Any item that is generally accepted as payment for goods and services is also the obvious choice for denominating the prices of those goods and services.

  • Store of Value: This function means that money can be used to purchase the same quantity of goods and services, that provide the same consumption value, in the future as it can purchase today. Inflation is the primary nemesis for the ability of money to store value.

<= STABLE EQUILIBRIUMSTAR TREK SCARCITY =>


Recommended Citation:

STANDARD OF DEFERRED PAYMENT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: October 21, 2017].


Check Out These Related Terms...

     | money functions | medium of exchange | unit of account | standard of deferred payment | value in use | value in exchange | commodity money | fiat money | money characteristics | M1 |


Or For A Little Background...

     | money | price | market | government functions | value | satisfaction | exchange | legal claim | inflation |


And For Further Study...

     | fractional-reserve banking | banking | money creation | monetary policy | Federal Reserve System | money supply | money supply, aggregate demand determinant | monetary economics | Keynesian economics | aggregate market analysis | business cycles |


Related Websites (Will Open in New Window)...

     | Federal Reserve System | Federal Reserve Education | U.S. Department of the Treasury |


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