UNIT 5
Money
Money may be anything chosen as the medium of exchange. According to some economist money is anything that performs the function of money. It is something which is widely accepted in payment for goods and services and in settlement of debts. In a modern society for commodities are expressed and valued in terms of money. In a wider sense, the term money includes all medium of exchange – Gold, Silver, Copper, Paper, Cheques, Commercial Bills of exchange, etc.
Barter means exchange of goods for goods. Barter system was in practice in the primitive society. Before the introduction of money, goods were directly exchanged for goods.
Under Barter system, the surplus of one commodity produced by ‘A’ would be exchanged for surplus of another commodity produced by ‘B’. Thus, barter is possible when both the parties have surplus and both of them need the commodities produced by each other.
- Absence of double co-incidence of wants: The major problem of barter system is the requirement of a double co-incidence of wants. For e.g. – Mr. A who has surplus of rice and requiring wheat must find out Mr. B who has surplus of wheat and requires rice. Such a double co-incidence of wants may not be always possible.
- Absence of common measure of value: There was no common measure of value under barter system the value of all commodities. Due to lack of a standard unit, pricing system was not possible. In every transaction, one commodity has to be valued in terms of another commodity. Thus, each exchange was independent and provided valuation of one commodity in terms of another commodity.
- Indivisibility: Only divisible goods can be exchanged under barter system. It was difficult to carry out exchange in case of indivisible goods. It is impossible to divide a Horse or a Goat for the purpose of exchange.
- Absence of medium of exchange: Under barter system there was no effective medium of exchange like money to facilitate exchange. Different goods were used as medium of exchange by different people at different places. It made the exchange more complicated.
- Lack of store of value: In barter system, it was difficult to store wealth as there was no stable store of value. Neither commodities nor animal could act as reliable store of value. As a result saving were discourage under barter system.
- Difficulties in settlement of debt: The most complicated problem under barter system was the settlement of deferred payments. Borrowing and lending in terms of identical commodities resulted in serious problems. For e.g. – Mr. A who borrowed Three Goat from Mr. B three years back may not be able to return them now the creditors may not accept them as they are older and useless.
Definition:-
- According to Prof. Walker, “Money is what money does.”
- According to R. P. Kent, “Money is anything which is commonly used and generally accepted as a medium of exchange or as a standard of value”
I Commodity money: In the initial stages of human development different commodities were used as money. E.g. Cattle, feathers, tusks, animal skin, salt, shells etc. The commodity chosen to serve as money (by common consent) depended upon various factors like climatic conditions, location, culture, economic development. E.g. People in the cold continents used skins and furs of animal as money. Whereas people living by the seashore used shells as medium of exchange.
This commodity money had certain limitations, like the perishable nature of commodity, the indivisibility of certain goods, problem of storage, etc.These problems of commodity money gave rise to introduction of Metallic Money.
I Metallic money: Metallic money having another two types –
a) Full-bodied money or Standard Coins
b) Token money or Token Coins
Full-bodied money or Standard Coins: A coin whose face value is equal to its intrinsic value is called Full bodied or full value money. According to Robertson, “Full value money is one whose face value i.e. the value defined by the government was one rupee and its contained silver worth rupee one. Its intrinsic value was (Silver content) was exactly equal to its face value (value defined by the government).
Token money or Token Coins: A token money or taken coin is one whose face value is much grater than its intrinsic value i.e. the value of its component material. The present Indian rupee coin is the best example the token coin. Its face value rupee on and it contains metal worth hardly twelve paisa. It is manufactured by the government as per its requirement.
I Paper money: It is of three type’s i.e. –
a) Representative Paper Money b) Convertible paper money
c) Inconvertible Paper Money
Representative Paper Money: This type of paper Money is fully backed by a metallic reserve. For the issue of such notes the monetary authority maintains 100% gold or silver reserve or Full-bodied coins. But now-a-days paper money is not fully backed by gold or silver. Hence representative paper money is not found anywhere in the world.
Convertible paper money: When the money issuing authority promises to convert notes into standard coins made of gold or silver on demand of public, it is called convertible paper money. The value of gold or silver kept in the reserve is less than (only 30 to 40%) the value of notes issued.
Inconvertible Paper money: When the note issuing authority does not make any commitment of converting notes into standard coins, it is called inconvertible paper money. At present paper money is of inconvertible type in all countries. Indian paper currency is also inconvertible as it cannot be converted into gold which is backing it.
I Bank money OR Credit money:
It refers to the bank deposits kept by people with banks, which are withdraw able at any point of time or can be transferred to someone else through an instrument called ‘cheque’. Cheque by itself is not money; it is a credit instrument which transfers the deposits.
Plastic money: In the modern world, new technology has replaced many cheque transactions with computer transfer. Today, debit cards and credit cards are used on large scale, but they do not have general acceptability. Use of plastic money involves transfer of balance in the bank account that is to be transferred among the customers. It is the balance in the bank account, that is transferred and not the plastic card.
Legal Tender money: It is the money which is backed by law and it can’t be refused by anybody on any ground. E.g. In India all coins and all currency notes are legal tender money.
Legal Tender money is of two types –
Limited legal tender money – It is that money which is accepted as legal tender, only upto a certain limited amount.
Unlimited legal tender – It is one which is to be accepted as a medium of payment, upto any amount.
Non-Legal Tender money OR Optional Money: It is the money which is generally used by people in final payments, but has no legal compulsion of acceptance. Therefore it can be refused Cheques; Bills of exchange etc. are example of optional money. From the point of view of the circulation, money is classified into
(a) Actual money (b) Money of account.
Actual Money: It is the money by the payment of which all transactions are actually made. E.g. All currency notes and metallic coins in India are actual money.
Money of Account: It is that money in terms of which the accounts of country are maintained. E.g. Rupee in India, Dollar in U.S.A. Etc.
Near Money: It indicates those assets which are not perfect medium of exchange thought they are good stores of value. They are to be converted into money first and then they can purchase other goods and services. E.g. Bills of exchange, equity shares, government securities, etc.
Qualities of Money:-
General acceptability: The materials which will act as money such that any one will accept it without hesitation for exchange. It must be acceptable to all otherwise; it cannot be useful medium of exchange.
Divisibility: It must be divisible so that all piece whatever values are of uniform quality. A bulk of money can be divided into the smaller number of coins or notes. For e.g. – one rupee is divided into 100 paisa.
Homogeneity: All coins of the same metal must be as nearly as possible of the same metal i.e. say one unit of a given money should be very much like another (one coin must not be superior to another) There should be uniformity.
Durability: The material chosen for money must be durable. It has to serve as a store of value. They must not perishable.
Stability of value: The money material should be purely stable in the value over period of time. This will make a good store and measure of value.
Portability: It must be portable or easy to carry. It must contain high value in small bulk, so that it can be carried from place without any difficulty.
Utility: A good money material should increase utility. According utility analysis money utility never tends to diminish.
Distinguishable: It manages that money must be clearly distinguishable and easily identifiable. For e.g. – Notes of different denominations must be of different size, colour, etc.
Attractive: Good money should be attractive with proper size, design and colour.
Functions of Money:-
Money performs various functions. Mainly the functions of money can be classified into three groups’ namely Primary functions Secondary function Contingent functions
Primary function: Primary functions are basic or fundamental function of money. Infact, they are the original functions of money which ensure smooth working of the economy. Following are the primary functions:
Medium of exchange: Money acts as an effective medium of exchange. It facilitates exchange of goods and services. Everything is bought and sold with help of money. By performing as the medium of exchange, money removes the difficulties of barter system.
Measure of value: Money serves as a common measure of value. The value of all goods and services are measured in terms of money. In other words, pieces of all goods and services are expressed in terms money. The pricing system unable a compare the value of different goods and services and each the right choice.
Secondary function: Secondary functions are those functions which are derived from primary function.
Standard of deferred payment: Money acts as an effective standard of deferred payments. Deferred payments refer to payment to be made in future. Deferred payments have become the day to day activity in modern society. Money facilitates all kinds of credit transactions. Both, borrowings as well as lending are done in terms of money. All kinds of Hire purchase transactions are carried out in terms of money. As money enjoys the attributes of stability, Durability and General acceptability, it acts as a better standard of deferred payments.
Store of value: Money serves as a store of value. Savings were discouraged under the barter system due to lack of store of value. With inventions of money, it is possible to save. At present all savings are done in terms of money. Bank deposits represent the savings of the people. Moreover, money can be easily converted into any other Marketable assets like Land, Machinery, Plant, etc. Thus it facilitates capital accumulation. Money being the most liquid assets, it acts as a better store of value than any other assets.
Transfer of value: Money acts as a means of transferring purchasing power. Money facilitates transfer of value from one person to another person & one place to another place. As money enjoys general acceptability, a person can dispose of his property in Delhi and purchase new property at Mumbai. Instrument like cheques and bank drafts enable such transfer easy and quick.
Contingent function: In additions to the above functions, money has to performs certain special function known as contingent functions –
Basis of credit: The modern business system is entirely linked to the credit system of the country. The credit system, on the other hand, derives its strength from money. In the absence of money, the credit instruments like cheque, bill of exchange, etc. are of no use. It is the quantity of money supply which determines the supply of credit in the country.
Measurement & Distribution of national income: The national income is the result of efforts contributed by various factors of production. Money is helpful in measuring the contribution made by each factor of production and thus facilitates the distribution of national income between factors.
Equalization of marginal utility: Every consumer is interested in spending his limited income in such a manner as to achieve maximum satisfaction (utility) for this purpose of achieving maximum satisfaction; he has to equalize marginal utilities from different goods. Money helps the consumer in equalizing marginal utilities.
Liquidity: Money being the most liquid asset, it can be converted into any other assets quickly. An entrepreneur has to keep capital in liquid form for various purposes, such as transaction, Precautionary and speculative motives. Money provides such liquidity.
Estimation of Macro Economic variables: Macro economic variables like Gross National Product, total savings, total investment etc. can be easily estimated in monetary terms. It also facilitates government tax collection, budgeting etc.
