In addition to the gold’s ability to serve, as an important medium of exchange, there were also three main rules to the Gold Standard; (i) All countries had to fix the price of gold in terms of their domestic currency. This was called the “mint price of gold.” (ii) Governments had to support the mint price for transactions with the public to assure that the mint price equaled to the market price of gold. Because, in the event the market price is higher (Market Price > Mint Price) than the mint price; then people would buy the gold from the government (i.e. from the Treasury Department of a given country) and the supply of gold in the market would go up while the market price of gold would go down. The opposite of this would happen whenever the market price of gold was lower than the mint price (Market Price < Mint Price). In that case, people would choose to sell the gold to the government and the supply of gold in the market would go down whereas the market price of gold would eventually go up.
A third most striking feature of the Gold Standard System was (iii) the fact that the melting of gold coins was legal. This would assure that the value of gold coins was same for monetary and non-monetary purposes.
At this point, some of us might inquire about the conditions as well as the factors that determine the value of money supply under the Gold Standard. An illustrative graphical example would help us explain the key determinants of the money supply of gold under this system.
Graph 1.1 shows that, the quantity of gold demanded for non-monetary purposes will go down and the quantity supplied of gold is also expected to increase after an increase in the price of gold. Under the Gold Standard System, the government will fix the mint price above the Po level to assure that there is an adequate supply of gold to make coins out of. At a mint price of Pm, the quantity demanded of gold for monetary purposes is the distance between the origin and point Q1, whereas the quantity supplied of gold equals the distance between the origin and point Q2. In this case, the distance between Q1 and Q2 or the range between points E and F will be the gold used in the making of coins. (i.e. excess supply of gold available for gold coins.)