What is Money? Discuss the functions of money.
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 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.
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.
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.