Money is any good that
is widely used and accepted in transactions involving the transfer of goods and
services from one person to another.
Economists
differentiate among three different types of money: commodity money, fiat
money, and bank money.
The functions of money
The function of money can be categorized in two classes. These are-
A. Primary or main function
B. Secondary or Supporting function
Primary or main function
Money is often defined in terms of
the four functions or services that it provides. Money serves as a medium of
exchange, as a Measure of Value, Standard of Deferred Payments and as Store of
Value.
1. Medium of Exchange:
The most important function of money
is to serve as a medium of exchange or as a means of payment. To be a
successful medium of exchange, money must be commonly accepted by people in
exchange for goods and services.
While functioning as a medium of
exchange, money benefits the society in a number of ways:
(a) It overcomes the inconvenience
of baiter system (i.e., the need for double coincidence of wants) by splitting
the act of barter into two acts of exchange, i.e., sales and purchases through
money.
(b) It promotes transactional
efficiency in exchange by facilitating the multiple exchange of goods and
services with minimum effort and time,
(c) It promotes allocation
efficiency by facilitating specialization in production and trade,
(d) It allows freedom of choice in
the sense that a person can use his money to buy the things he wants most, from
the people who offer the best bargain and at a time he considers the most
advantageous.
2. Measure of Value:
Money serves as a common measure of
value in terms of which the value of all goods and services is measured and
expressed. By acting as a common denominator or numeraire, money has provided a
language of economic communication. It has made transactions easy and
simplified the problem of measuring and comparing the prices of goods and
services in the market. Prices are but values expressed in terms of money.
Money also acts as a unit of
account. As a unit of account, it helps in developing an efficient accounting
system because the values of a variety of goods and services which are
physically measured in different units (e.g, quintals, metres, litres, etc.)
can be added up. This makes possible the comparisons of various kinds, both
over time and across regions. It provides a basis for keeping accounts, estimating
national income, cost of a project, sale proceeds, profit and loss of a firm,
etc.
To be satisfactory measure of value,
the monetary units must be invariable. In other words, it must maintain a
stable value. A fluctuating monetary unit creates a number of socio-economic
problems. Normally, the value of money, i.e., its purchasing power, does
not remain constant; it rises during periods of falling prices and falls during
periods of rising prices.
3. Standard of Deferred Payments:
When money is generally accepted as
a medium of exchange and a unit of value, it naturally becomes the unit in
terms of which deferred or future payments are stated.
Thus, money not only helps current
transactions though functions as a medium of exchange, but facilitates credit
transaction (i.e., exchanging present goods on credit) through its function as
a standard of deferred payments. But, to become a satisfactory standard of
deferred payments, money must maintain a constant value through time ; if its
value increases through time (i.e., during the period of falling price level),
it will benefit the creditors at the cost of debtors; if its value falls (i.e.,
during the period of rising price level), it will benefit the debtors at the
cost of creditors.
4. Store of Value:
Money, being a unit of value and a
generally acceptable means of payment, provides a liquid store of value because
it is so easy to spend and so easy to store. By acting as a store of value,
money provides security to the individuals to meet unpredictable emergencies
and to pay debts that are fixed in terms of money. It also provides assurance
that attractive future buying opportunities can be exploited.
Money as a liquid store of value
facilitates its possessor to purchase any other asset at any time. It was
Keynes who first fully realised the liquid store value of money function and
regarded money as a link between the present and the future. This, however,
does not mean that money is the most satisfactory liquid store of value. To
become a satisfactory store of value, money must have a stable value.
Secondary or Supporting function
1. Transfer of Value:
Money also functions as a means of
transferring value. Through money, value can be easily and quickly transferred
from one place to another because money is acceptable everywhere and to all.
For example, it is much easier to transfer one lakh rupees through bank draft
from person A in Amritsar to person B in Bombay than remitting the same value
in commodity terms, say wheat.
2. Distribution of National Income:
Money facilitates the division of
national income between people. Total output of the country is jointly produced
by a number of people as workers, land owners, capitalists, and entrepreneurs,
and, in turn, will have to be distributed among them. Money helps in the
distribution of national product through the system of wage, rent, interest and
profit.
3. Maximization of Satisfaction:
Money helps consumers and producers
to maximize their benefits. A consumer maximizes his satisfaction by equating
the prices of each commodity (expressed in terms of money) with its marginal
utility. Similarly, a producer maximizes his profit by equating the marginal
productivity of a factor unit to its price.
4. Basis of Credit System:
Credit plays an important role in
the modern economic system and money constitutes the basis of credit. People
deposit their money (saving) in the banks and on the basis of these deposits,
the banks create credit.
5. Liquidity to Wealth:
Money imparts liquidity to various forms of
wealth. When a person holds wealth in the form of money, he makes it liquid. In
fact, all forms of wealth (e.g., land, machinery, stocks, stores, etc.) can be
converted into money.