MONEY

Money is one of the fundamental inventions of mankind. It has become so important

that the modern economy is described as the money economy. The modern economy
cannot work without money. Even in the early stages of economic development, the
need for exchange arose. At first, the family or village was a self-sufficient unit. But
later on, with the development of agriculture and application of the division of labor—
that is, the division of the society into agriculturists, carpenters, merchants, and so
on—the need for exchange arose. Exchange took place first in the form of barter.
Barter is the direct exchange of goods for goods. Barter is a system of trading without
the use of money. At first, when the wants of men were few and simple, the barter
system worked well. But as days passed by, it was found to be unsuitable. It has
many difficulties.

Money has been defined differently by different economists. Some, like F.A. Walker,
define it in terms of its functions, while others like G.D.H. Cole, J.M. Keynes, Seligman
and D.H. Robertson lay stress on the ‘general acceptability’ aspect of money.

According to Prof. D.H. Robertson, “anything which is widely accepted in payment for
goods or in discharge of other kinds of business obligation, is called money.” Seligman
defines money as “one thing that possesses general acceptability.” Prof. Ely says:
“Money is anything that passes freely from hand to hand as a medium of exchange
and is generally received in final discharge of debts.”

Difficulties of Barter

The barter economy presents many difficulties:

 Absence of double coincidence of wants: Barter requires a double coincidence of

wants. That is, one must have what the other man wants, and vice versa. This is
not always possible. For example, say I want a cow. You must have it. If you want
a horse in return, I must have it. But if I do not have it, exchange cannot take
place. So, I should go to a person who has a horse, and I must have what he
wants. All of this means a lot of inconvenience. But money overcomes these
difficulties. If I have an object, I can sell it for some price. I get the price in money.
With that, I can buy whatever I want.
 No standard of measurement: Barter provides no standard of measurement. In
other words, it provides no measure of value. It does not provide a method for
estimating the relative value of two goods.

 Absence of subdivision: Sometimes it will be difficult to split up commodities into

parts. They will lose their value if they are subdivided. For example, say a man
wants to sell his house and buy some land, some cows, and some cloth. In this
case, it is almost impossible for him to divide his house and barter it for all the
above things. Again, suppose a man has diamonds. If he divides them, he will
make a great loss.

 Difficulty of storage: Money serves as a store of value. In the absence of money, a

person has to store his wealth in the form of commodities, and they cannot be
stored for a long period. Some commodities are perishable, and some will lose
their value.

FEATURES OF MONEY

 First, to serve as an effective medium of exchange, money must be durable.

Repeating our earlier example, we could have chosen to use apples as money
and pay for everything in apples. But problems arise when the apples rot. Who
wants to carry around rotten apples? Good apples tend to be eaten, and
nothing could erode the value of your money more quickly than having it end
up in your stomach.
 Second, what serves as money must not be easily reproduced by people and
should be relatively scarce. We could use chestnuts as money. They’re relatively
scarce and last a long time. But, if we did, people would start growing chestnut
trees, and we wouldn’t be able to control the supply. Soon there would be so
many chestnuts in use, and prices would be bid up so high, that you’d need a
truck to carry the chestnuts to pay for bread and milk. We could use rocks, but
everyone can simply pick up rocks from all over the place.
 Third, although what serves as money must be relatively scarce (not rocks, for
example), it can’t be too scarce. Whatever serves as money has to be available
in sufficient quantity to enable all the exchanges in our economy to take place.
We could use whooping cranes. But there wouldn’t be enough of them to enable
 all the exchanges that have to take place. We would very quickly run out of
money—to say nothing of the poor birds.
 Fourth, money has to be easy to transport. We could use elephants. But just
think of all the problems at pay-day if elephant money was used to provide your
wage or salary. Pocket money would take on a whole, or should we say Whole,
new meaning.
 And last, money must be divisible into usable quantities or fractions. Imagine
the difficulties you would incur to purchase something that had a price of
1/50th of an elephant. Not a pleasant thought. So money needs to be (1)
durable, (2) not easily reproduced by people, (3) relatively scarce, (4) not too
scarce, (5) easily transported, and (6) divisible. But, as we emphasized earlier,
the most essential attribute of anything that serves as money is its
acceptability. It must be readily accepted by people in the economy.

 Functions of Money

All the difficulties of barter were overcome with the introduction of money. Crowther
had defined money as “anything that is generally acceptable as a means of exchange
(i.e., as a means of settling debts) and that at the same time acts as a measure and as
a store of value.” An important point about this definition is that it regards anything
that is generally acceptable as money. Thus, money includes coins, currency notes,
cheques, Bills of Exchange, and so on. It is not always easy to define money. That is
why Prof. Walker has said that money is that which money does. By this, he refers to
the functions of money. Money performs many functions in a modern economy. The
most important functions are given in the form of a couplet quoted below. “Money is a
matter of functions four - a medium, a measure, a standard, a store.”

A. Primary Function

1. Medium of exchange:
Money serves as a medium of exchange and facilitates the buying and selling of goods,
thereby eliminating the need for double coincidence of wants as under barter. A man
who wants to sell wheat in exchange for rice can sell it for money and purchase rice.
2. Measure of value:
Money has also removed the difficulty of barter system by serving as a common
measure of value. The values of various commodities are expressed in terms of money.
Money as a measure of value has made transactions simple and easy. It may be
understood that this function of money follows from the first basic function (medium
of exchange). It is because money is used as a medium to exchange goods, that each
good gets a value in terms of money (called price). As such, money also serves as a
unit of account. In India, the unit of account is the Rupee, in USA, the Dollar; in
USSR, the Rouble and the Yen in Japan.

B. SECONDARY FUNCTION-

1. Store of Value:
Classical economists did not recognize the store of value function of money. Keynes
laid stress on this function of money. People store money to provide again the rainy
day and to meet unforeseen contingencies. According to Keynes, people also store
money to take advantage of the changes in the rate of interest. Money as a store
preserves value through time and space. Money as a store of value through time
means the shifting of purchasing power from the present to the future and as such it
serves as an important link between the present and the future.

Money in this case is stored as a form of ‘asset’. Money is an asset or a form of wealth
because it is a claim. It is the most convenient way of laying claim to such goods and
services as one wishes to buy. Thus, rather than keeping their wealth in the form of
non-liquid assets like houses, shares, etc., people prefer to keep their wealth in the
form of money. Money is the most liquid of all assets i.e., money can be readily
exchanged for goods and services without any difficulty and the price of money or its
value is stable at least over a short period. In fact, all assets like bonds, saving
accounts, treasury bills, government securities, inventories and real estate do serve as
stores of value, but they differ in the degree of liquidity; money amongst these
possesses highest degree of liquidity and that is why people prefer it most as a store of
value.
However, we should not give it undue importance because the value of money does not
remain stable through time. As prices rise, people try to get rid of money as its value
falls. Moreover, in modern economies storing wealth in the form of money is
unimportant as it is done in the form of interest-bearing securities.

Money as a store of value through space continues to be important; for instance, an

Indian businessman who sells his business and property and goes to USA and settles
down there is a case of exporting value through space. In ancient times, gold and
silver coins were used as a store of value followed by currency notes. In advanced
countries today money is stored in the form of bank deposits.

2. Standard of Deferred Payments:

Money has always been used as a standard of deferred payment. This function of
money has attained more importance in modern times with the extension of trade
based on credit. As a result of this function, it has become possible to express future
payments in terms of money. A borrower who borrows a certain sum in the present
undertakes to pay the same in future. Similarly, a person who purchases on credit
agrees to pay in future when his bills become due. Money as a standard of deferred
payments is performing useful function enabling the current and present transactions
to be discharged in future.

3. Standard of Postponed Payment:

This is an extension of the first function. Here again money is used as a medium of
exchange, but this time the payment is spread over a period of time. Thus, when goods
are bought on hire-purchase, they are given to the buyer upon payment of a deposit,
and he then pays the remaining amount in a number of installments.

Under the barter system this type of transaction could involve problems. Imagine a
farmer buying a video-recorder and agreeing to pay for it in terms of a fixed amount of
wheat each week for a certain number of weeks. After a few weeks the seller of the
video recorder might have more than enough wheat.

Yet he will have to receive more wheat in the coming weeks. If money had been used,
the seller could then use it to buy whatever he wanted, whether it is wheat or
something else—now or in future. In other words, the use of money permits
postponement of spending from the present to some future occasion.

In a modern economy, most transactions (buying and selling) are made on the basis of
credit. For example, it is possible to purchase consumer durables such as T.V. sets or
washing machines on hire-purchase; houses may be purchased by means of L.I.C. or
H.D.F.C. loan; most business dealings permit payment in the future for goods
delivered now; and employees wait for a month or a week to receive their wages and
salaries. Thus, the use of money permits the members of society to defer their
spending from the present to some future date.

We, therefore, see that a money system clearly has advantages over a barter system.
But what is money? Note the first five words in our definition – “anything which is
generally acceptable.” We use notes and coins to buy things but can do so only as long
as shopkeepers and traders are prepared to accept those notes and coins in payment
for the goods they are selling. If all sellers decided that they would no longer accept
these notes and coins, then these would cease to be money. If they decided instead to
accept chair legs as money, then we would have to use chair legs which we would have
to use when buying something! This example, of course, is rather ridiculous but what
it points out is that anything can be money as long as it is generally acceptable as
such.

C. Contingent Functions:
Besides, the primary and secondary functions of money, Prof. Kinley lays stress on the
contingent functions of money. Money facilitates the distribution of national income
among the various factors of production. Land, labour, capital and organization all co-
operate in an act of production and the product is the result of their joint efforts,
which belongs to all of them.

Money makes the distribution of joint production, amongst various factors easy and
paves the way for economic progress. Further, a concept like utility is measured in
terms of money. A consumer as well as a producer measures the utilities of different
goods and factors of production with the help of money and try to get maximum
satisfaction or maximum returns.
Again, credit is the basis of modern economic progress. Money constitutes the basis of
credit. Banks create credit not out of thin air but with the help of money. Moreover,
money gives liquidity to various forms of wealth. A person by keeping his wealth in the
form of money renders it most liquid.

Thus, we find that money performs many functions—a medium of exchange, a

measure of value, a store of value, a standard of deferred payments and serves as a
basis for credit and distribution of national income. These functions of money are not
all of the same importance. Of all the functions, the most important function of money
is that it serves as a medium of exchange and as such also becomes a means of
payment. Money in the form of a generally acceptable commodity, in the process of
exchange between goods, at once, becomes a unit of account and a measure of value.
The following table clearly shows the various functions of money.

Qualities of a Good Money Material/ Features of Money

1. General acceptability: A good money material must be generally acceptable.

People should not hesitate to exchange their goods for the material. Precious
metals like gold and silver are always acceptable.

2. Portability: A satisfactory money material must be of high value for its bulk. Since
it has to be moved about from place to place, it must be possible for us to carry it
from one place to another without difficulty, expense, or inconvenience. Precious
metals such as gold and silver are satisfactory in this regard. Even paper money
is ideal in this regard. Iron, for instance, would not be satisfactory in this respect.
3. Cognizability: The material used as money should be easily recognizable. Gold
and silver, for example, can be easily recognized by their color and heavy weight
for small bulk.

4. Durability: The material used as money should not deteriorate. The early forms of
money such as corn, fish, and skin were unsuitable in this regard. Gold coins will
last many hundreds of years.

5. Divisibility: The money material should be capable of division; and the aggregate
value of the mass after division should be almost exactly the same as before. If we
use diamond as money and by chance it drops from our hand and breaks, we will
suffer an enormous loss. This is not the case with precious metals. Their portions
can be melted and remelted together any number of times without much loss.

6. Homogeneity: All portions or specimens of the substance used as money should

be homogeneous, that is, of the same quality, so that equal weights have exactly
the same value. In order that a commodity may be used as a measure of value, it
is essential that its units are similar in all respects. Gold and silver are of the
same quality throughout; their various parts are similar in chemical and physical
composition and their consistency is the same throughout the mass.

7. Malleability: The money material should be capable of being melted, beaten and
given convenient shapes. It should be neither too hard nor too soft. If the former,
it cannot be easily coined; If the latter, it would not last long. It should also
possess the attribute of impressionability so that it may easily receive the
impressions.

8. Stability of value: This is another important quality of a good money material.

Commodities, which are subject to violent changes in supply and demand, are
unfit for money. For, the value of money, like any other thing, is determined by its
supply and demand. If there are violent changes in its supply and demand, its
value is not likely to be stable. Since money is used as a store of value and
standard of deferred payments, it cannot perform these two functions well, if there
is no stability of value for money. If money goes on losing its stability of value, it
will not be accepted as money.