Functions of Money

The following points highlight the top six functions of

money.
Function # 1. A Medium of Exchange:
The only alternative to using money is to go back to the barter system.
However, as a system of exchange the barter system would be highly
impracticable today.

For example, if the baker who supplied the green-grocer with bread
had to take payment in onions and carrots, he may either not like
these foodstuff or he may have sufficient stocks of them.

The baker would, therefore, have to re-sell the product which would
take time and be very inconvenient. By replacing these complicated
sales by the use of money it is possible to save a lot of trouble. If the
baker accepts payment in money this can be spent in whatever way the
baker wishes. The use of money as a medium of exchange overcomes
the drawbacks of barter.

Thus, money provides the most efficient means of satisfying wants.

Each consumer has a different set of wants. Money enables him (her)
to decide which wants to satisfy, rank the wants in order of urgency
and capacity (income) and act accordingly.

This type of system also enables specialisation to extend. Take, for

example, a person who performs only a single task in a shoe factory.
He has not actually produced anything himself. So what could he
exchange if a barter system were in operation? With money system the
problem is removed. He can be paid in terms of money and can use
that money to buy what he wants.

Function # 2. A Measure of Value:

Under the barter system, it is very difficult to measure the value of
goods. For example, a horse may be valued as worth five cows or 100
quintals of wheat, or a Maruti car may be equivalent to 10 two-
wheelers. Thus one of the disadvantages of the barter system is that
any commodity or service has a series of exchange values.

ADVERTISEMENTS:

Money is the measuring rod of everything. By acting as a common

denominator it permits everything to be priced, that is, valued in
terms of money. Thus, people are enabled to compare different prices
and thus see the relative values of different goods and services.

This serves two basic purposes:

(1) Households (consumers) can plan their expenditure and

(2) Business people can keep records of income and costs in order to
work out their profit and loss figures.

Function # 3. A Store of Value (Purchasing Power):

ADVERTISEMENTS:

A major disadvantage of using commodities — such as wheat or salt or

even animals like horses or cows — as money is that after a time they
deteriorate and lose economic value. They are, thus, not at all
satisfactory as a means of storing wealth. To realise the problems of
saving in a barter economy let us consider a farmer. He wanted to save
some wheat each week for future consumption. But this would be of no
use to him in his old age because the ‘savings’ would have gone off.

Again, if a coal miner wanted to set aside a certain amount of coal each
week for the same purpose, he would have problems of finding enough
storage space for all his coal. By using money, such problems can be
overcome and people are able to save for the future. Modern form of
money (such as coins, notes and bank deposits) permit people to save
their surplus income.

Thus money is used as a store of purchasing power. It can be held over

a period of time and used to finance future payments. Moreover, when
people save money, they get the assurance that the money saved will
have value when they wish to spend it in the future. However, this
statement holds only if there is no severe inflation (or deflation) in the
country.

In other words, it is quite obvious that money can only act effectively
as a store of value if its own value is stable. If, for example, most
people feel that their savings would become worthless very soon, they
would spend them at once and save nothing. For the last few years the
value (or the purchasing power) of money has been falling in India.
Yet in the short run—for day-to-day purposes—money has sufficient
stability of value to serve quite well as a store of value.

Function # 4. The Basis of Credit:

Money facilitates loans. Borrowers can use money to obtain goods and
services when they are needed most. A newly married couple, for
example, would need a lot of money to completely furnish a house at
once. They are not required to wait for, say ten years, so as to be able
to save enough money to buy costly items like cars, refrigerators, T.V.
sets, etc.

Function # 5. A Unit of Account:

An attribute of money is that it is used as a unit of account. The
implication is that money is used to measure and record financial
transactions as also the value of goods or services produced in a
country over time. The money value of goods and services produced in
an economy in an accounting year is called gross national product.
According to J. R. Hicks, gross national product is a collection of
goods and services reduced to a common basis by being measured in
terms of money.

Function # 6. A 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.

ADVERTISEMENTS:

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.
What is a Barter System?
A barter system is an old method of exchange. Th is system has been used for centuries
and long before money was invented. People exchanged services and goods for other
services and goods in return. Today, bartering has made a comeback using techniques that
are more sophisticated to aid in trading; for instance, the Internet. In ancient times, this
system involved people in the same area, however today bartering is global. The value of
bartering items can be negotiated with the other party. Bartering doesn't involve money
which is one of the advantages. You can buy items by exchanging an item you have but no
longer want or need. Generally, trading in this manner is done through Online auctions and
swap markets.

History of Bartering

The history of bartering dates all the way back to 6000 BC. Introduced by Mesopotamia
tribes, bartering was adopted by Phoenicians. Phoenicians bartered goods to those located
in various other cities across oceans. Babylonian's also developed an improved bartering
system. Goods were exchanged for food, tea, weapons, and spices. At times, human skulls
were used as well. Salt was another popular item exchanged. Salt was so valuable that
Roman soldiers' salaries were paid with it. In the Middle Ages, Europeans traveled around
the globe to barter crafts and furs in exchange for silks and perfumes. Colonial Americans
exchanged musket balls, deer skins, and wheat. When money was invented, bartering did
not end, it become more organized.

Due to lack of money, bartering became popular in the 1930s during the Great Depression.
It was used to obtain food and various other services. It was done through groups or
between people who acted similar to banks. If any items were sold, the owner would receive
credit and the buyer's account would be debited.

Disadvantages and Advantages of Bartering

Just as with most things, there are disadvantages and advantages of bartering. A
complication of bartering is determining how trustworthy the person you are trading with is.
The other person does not have any proof or certification that they are legitimate, and there
is no consumer protection or warranties involved. This means that services and goods you
are exchanging may be exchanged for poor or defective items. You would not want to
exchange a toy that is almost brand new and in perfect working condition for a toy that is
worn and does not work at all would you? It may be a good idea to limit exchanges to family
and friends in the beginning because good bartering requires skill and experience. At times,
it is easy to think the item you desire is worth more than it actually is and underestimate the
value of your own item.

On the positive side, there are great advantages to bartering. As mentioned earlier, you do
not need money to barter. Another advantage is that there is flexibility in bartering. For
instance, related products can be traded such as portable tablets in exchange for laptops.
Or, items that are completely different can be traded such as lawn mowers for televisions.
Homes can now be exchanged when people are traveling, which can save both parties
money. For instance, if your parents have friends in another state and they need
somewhere to stay while on a family vacation, their friends may trade their home for a week
or so in exchange for your parents allowing them to use your home.

Another advantage of bartering is that you do not have to part with material items. Instead,
you can offer a service in exchange for an item. For instance, if your friend has a
skateboard that you want and their bicycle needs work, if you are good at fixing things, you
can offer to fix their bike in exchange for the skateboard. With bartering two parties can get
something they want or need from each other without having to spend any money.

 Building a Government

 Ancient Egyptians

 Mrs. Lawson's AIM Page

 Watervliet North School Resource Page

 Social Studies Resource Page

 Tumble Book Library

 Mrs. Leonard's Site

 Little Silver Schools Resource Page

 Barter Works

 Bartering Lesson Plan PDF

 Bartering through the Seasons PDF

 How Bartering Works

 Bartering Lesson Plan: A System of Exchange

 Bartering Game PDF

 Bartering: An Early Form of Interdependence Lesson Plan

 Economy and Money

 History of Money

 Learn about Money

 Money Mania: History

 The Barter System

 The major limitations of Barter

Exchange are:
 1. Lack of Double Coincidence of Wants:
 Barter system can work only when both buyer and seller are
ready to exchange each other’s goods. For example, A can
exchange goods with B only when A has what B wants and B has
what A wants. However, such double coincidence is very rare.

 2. Lack of Common Measure of Value:

 ADVERTISEMENTS:

 In the barter system, all commodities are not of equal value and
there is no common measure (unit) of value of goods and
services, in which exchange ratios can be expressed. For
example, if A has wheat and B has rice, then it is difficult to
decide, how much wheat is needed to exchange with one
kilogram of rice. In the absence of common measure, the
exchange ratio is fixed randomly, in which one of the party
generally suffers.
 Barter system can work with few commodities in the primitive
society. However, it is very difficult in the modern economy,
where we need millions of exchange ratios for a large number of
goods and services.

 3. Lack of Standard of Deferred Payment:

 Under barter system, contracts involving future
payments or credit transactions cannot take place with
ease because of following reasons:
 ADVERTISEMENTS:

 (a) The borrower may not be able to arrange goods of exactly

same quality at the time of repayment.

 (b) There may be conflicts regarding which specific commodity is

to be used for repayment.

 (c) The commodity to be repaid may lose or gain its value at the
time of repayment.

 So, it is very difficult to make deferred payments in the form of

goods.

 ADVERTISEMENTS:

 4. Lack of Store of Value:

 Under barter system, it is difficult for people to store
wealth for future use because:
  (a) Most of the goods (like wheat, rice, vegetables, etc.) do not
possess durability, i.e. their quality deteriorates with passage of
time.

 (b) Storage of goods requires time and efforts.

 As a result, goods cannot be used to store the earnings for a long

period.

 With so many difficulties, barter exchange could not continue for

a long time. As a result, it was replaced by monetary exchange,
i.e. buying and selling of goods with the help of ‘Money’. Money
has been defined differently by different economists. The most
acceptable definition of money can be stated in terms of all the
functions of money. So, let us first discuss the main functions of
money.
What is Money Supply?
The money supply is the entire stock of currency and other liquid instruments
circulating in a country's economy as of a particular time. The money supply can
include cash, coins, and balances held in checking and savings accounts, and
other near money substitutes. Economists analyze the money supply as a key
variable to understanding the macroeconomy and guiding macroeconomic policy.

KEY TAKEAWAYS

 Money Supply is the total quantity of money in circulation at a point in time.

 Changes in the money supply are closely watched because of the
relationship between money and macro economic variables such as
inflation.
 The money supply can be measured in a various ways using narrower or
broader definitions of which classes of financial assets are considered to
be money.
Features of Money Supply:
1. It includes ‘money held by public only’. The term ‘public’ signifies
the money-using sector, i.e. individuals and business firms. It does not
include money-creating sector, i.e. Government and banking system as
cash balances held by them do not come into actual circulation in the
country.

Features of Money Supply:

1. It includes ‘money held by public only’. The term

‘public’ signifies the money-using sector, i.e. individuals
and business firms. It does not include money-creating
sector, i.e. Government and banking system as cash
balances held by them do not come into actual
circulation in the country.

2. Measures of Money
Supply:
Till 1967-68, Reserve Bank of India (RBI) used only the narrow
measure of money supply. But, since 1977, four alternative measures
of money supply (M1, M2, M3 and M4) have been evolved:
(I) M1:
ADVERTISEMENTS:

It is the first and basic measure of money supply. It is also known as

‘transaction money ‘ as it can be directly used for making transactions.
M1 = Currency and coins with Public + Demand Deposits of
Commercial Banks + Other Deposits with RBI
M1 is the most liquid measure of money supply as all its components
are easily used as a medium of exchange.
1. Currency and coins with Public:
ADVERTISEMENTS:

It consists of paper notes and coins held by the public. Remember, any
currency held with the government and banks is not to be included.

2. It includes coins of denominations of Rs 10, 5, 2, 1, etc. and paper

notes of denominations like Rs 1,000, 500, 100, etc.
3. Currency money is also termed as ‘Fiat Money’. Fiat money is
defined as the money which is under the fiat or order from the
government to act as money, i.e. under law, it must be accepted for all
debts.
4. It is also termed as ‘Legal Tender Money’ as it can be legally used to
make payment of debts or other obligations.
ADVERTISEMENTS:

5. Demand Deposits of Commercial Banks:

It refers to demand deposits of the public with the commercial banks.
Demand deposits are the deposits, which can be encased by issuing
cheques at any time by the account holders. A demand deposit is
treated as equal to currency held as it is readily accepted as a means of
payment.

Only Net Demand Deposits are included:

It must be noted that demand deposits are taken on net basis, i.e.
inter-bank deposits are excluded. Inter-bank deposits are the deposits
held by banks on behalf of other banks. Such deposits do not form a
part of the money supply, as they do not belong to the public.

ADVERTISEMENTS:

1. Other deposits with Reserve Bank of India (RBI):

It include deposits held by the RBI on behalf of foreign banks and
governments, public financial institutions, World Bank, IMF, etc.
However, it does not include deposits of the Indian Government and
commercial banks with RBI.

It must be noted that ‘Other deposits with RBI’ constitute a very small
proportion of M1. Therefore, they do not have any significant role to
play in the monetary policy formulation.
(ii) M2:
It is a broader concept of money supply as compared to M1. In addition
to M1, it also includes savings deposits with post office saving bank.
M2 = M1 + Savings deposits with Post Office Saving Bank
‘Savings deposits with Post Office Saving Bank’ is not withdrawable by
cheque. So, they could not be placed under demand deposits with
bank. As a result, the concept of M2 was evolved.
(iii) M3:
This concept is broader as compared to M1, In addition to M1; it also
includes net time deposits.
M3 = M1 + Net Time Deposits with Banks
(iv) M4:
This measure includes total deposits with post office saving
bank in addition to M3.
M4 = M3 + Total Deposits with Post Office Saving
Bank(Excluding NSC)
NSC is National Saving Certificate

Important Facts about Measures of Money Supply:

ADVERTISEMENTS:

i. The four measures of money supply represent different degrees of

liquidity, with M1 being the most liquid and M4being the least liquid.
ii. M3 is widely used as a measure of money supply and it is also known
as ‘aggregate monetary resources of the society’.
iii. M1 and M2 are generally known as narrow money supply concepts,
whereas, M3 and M4 are known as broad money supply concepts.

BANKING
How It Works

Banks are a safe place to deposit excess cash. The Federal Deposit Insurance
Corporation (FDIC) insures them. Banks also pay savers interest rates or a small
percent of the deposit.

Banks can turn every one of those saved dollars into $10. They are only required
to keep 10 percent of each deposit on hand. That regulation is called the reserve
requirement. Banks lend the other 90 percent out. They make money by charging
higher interest rates on their loans than they pay for deposits.
A central bank, reserve bank, or monetary authority is the institution that
manages the currency, money supply, and interest rates of a state or formal monetary union,[1] and
oversees their commercial banking system. In contrast to a commercial bank, a central bank
possesses a monopoly on increasing the monetary base in the state, and also generally controls
the printing/coining of the national currency,[2] which serves as the state's legal tender.[3] A central
bank also acts as a lender of last resort to the banking sector during times of financial crisis. Most
central banks also have supervisory and regulatory powers to ensure the solvency of member
institutions, to prevent bank runs, and to discourage reckless or fraudulent behavior by member
banks.