Buy Now, Pay Later

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

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

• 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.