"Money is anything which is widely accepted in Payments for goods, or in discharge of other kinds of Business Obligations"
Teaching Points
10.1 Introduction
10.2 Difficulties in Barter Exchange (in brief)
10.3 Definition of Money
10.4 Evolution of Money & Types of Money – Commodity Money, Metallic Money, Paper Money, Plastic Money
10.5 Function of Money – Primary Functions, Secondary Function & Contingent Functions
Teaching Objectives
To make the students aware of the types of money and its various fuctions
EVOLUTION OF MONEY
The decision to invest is a commitment to the future
10.1 Introduction
Different goods and services are consumed to satisfy human wants. Today these goods and services are conveniently purchased and sold with the help of money, which is a common medium of exchange and has general acceptability.
Barter System
Before introduction of money, there existed Barter System. It indicates exchange of good with goods and services e.g. exchange of rice with cloth, milk etc. In a primitive society there was existence of self-sufficient village economy, which was based on division of labour. Human needs were simple and limited compared to those of the modern world. Surplus goods, which man had, were exchanged with other commodity or service, but with the rise in the number of goods and services produced, exchange of goods with goods and with services became difficult. Man started facing many difficulties in this Barter System which are as follows.
10.2 Difficulties in Barter Exchange :
(Barter System)
1. Lack of double co-incidence of wants.
2. Lack of common measure of value.
3. Difficulty of storage of goods.
4. Problem of indivisibility.
5. Problem of making deferred payments.
1. Lack of double co-incidence of wants - Double co-incidence of wants indicates need of each other's goods and willingness to accept it. Lack of double co-incidence of wants was one of the important limitations of Barter system. e.g. Person "A' has cloth and he wants rice in exchange and the person `B' has wheat and he wants milk in exchange. In this case exchange between `A' and `B' would not take place as both are not in need of each other's goods.
2. Lack of common measure of value - In the absence of common measure of value or a unit of account, it was difficult to calculate the values of the goods exchanged. Exchange became difficult in the case of goods which could not be compared, e. g.. It was difficult to compare 2 litres of milk with 2 kgs of onions. At the same time it was difficult to compare certain units of a commodity with any service.
3. Difficulty of storage of goods - Under barter exchange, it was necessary to store goods for future consumption. Storage of highly perishable goods like fish, vegetables, milk etc. was difficult, besides there were space constraints.
4. Problem of indivisibility - Under barter system, it was difficult to make fractional payments, especially when things to be exchanged were indivisible e.g. Person `X' had a bag of rice which he wanted to exchange for a plough, with person `Y', but suppose `Y' wanted only half a bag of rice, then it would be difficult to offer half of the plough.
5. Problem of making deferred payments - Deferred payments are those which are made in future. When people used to borrow cattle, it was difficult to return the cattle in the same physical conditions, after a certain number of years.
Thus, various difficulties faced under the Barter System gave rise to money. Invention of money is one of the most fundamental invention.
Money is defined differently by different economists. There is no unique definition of money. Some economists have defined money on the basis of its functions, while some others have defined it on the basis of its general acceptability. Some of the definitions of money are as follows:
• According to Prof. EA. Walker, "Money is what money does."
• According to Prof. Crowther, "Money is anything that is generally acceptable, as a means of exchange and which, at the same time, acts as a measure and store of value."
• D.H. Robertson defines money as "anything which is widely accepted in payments for goods, or in discharge of other kinds of business obligations."
After discussing various definitions of money it is necessary to study the evolution of money and the types of money.
10.4 Evolution of Money and Types of Money
Various difficulties of Barter exchange led to the development of the stage, where a generally acceptable commodity served as a medium of exchange. In the early days of civilisation, in primitive farming communities money took the form of animals. e.g. domestic animals like cows, sheep, goat etc. Afterwards commodity money was used. Problems of using commodity money gave rise to metallic money. Various limitations of metallic money resulted in the introduction of paper money. Modernization gave rise to bank money and plastic money.
Type of Money -
1. 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 etc., e.g. people in the cold continents used skins and furs of animals as money. Whereas people living by the seashore used shells as a 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.
2. Metallic Money
Introduction of metallic coins made of silver, gold, copper, iron etc., is considered as an important stage in the evolution of modern monetary system. Various defects of commodity money like perishability, heterogeneity, indivisibility gave rise to introduction of metallic money. Some characteristics of metals like continuity of supply, high and stable price, scope for division etc., made these metals serve as an excellent medium of exchange.
In early days, rulers of various kingdom minted metallic coins. Later it was minted by private bankers. They used to put their seal on these coins, certifying the weight and purity of the metal. After a certain period of time the monetary system was taken over by the government authorities with a view to give uniformity and legal status to the coins. Metallic coins can be divided into two categories.
a) Standard or full-bodied coins
b) Token coins.
a) Standard or full bodied coins - Full bodied coins are those whose face value is equal to their intrinsic value. Face value indicates the exchange value, fixed by the issuing authority and which is embossed on it. Intrinsic value is the value of the metal content present in the coin. These coins were made out of standard metals like gold and silver.
b) Token coins - Token coins are those whose face value is higher than their intrinsic value. These coins are made out of cheaper metals like aluminium, nickel etc. These coins are of lower denomination and generally used for settling small transactions. In India all coins in circulation today are token coins.
3. Paper Money or Paper Currency
Paper currency had its origin in the form of deposit receipts issued by private bankers in olden days. Paper money was a substitute for metallic money. In course of time, note issue was monopolized by the Central Bank. Paper money consists of the currency notes issued by the Government or Central Bank of the country. In India one rupee currency notes and all coins are issued by the Government of India and all other currency notes are issued by The Reserve Bank of India.
Following factors gave rise to the introduction of paper money.
1) Difficulty in transferring large sums of metallic money.
2) Supply of gold and silver lagging far behind the demand for money.
3) Loss of weight and value of coins due to wear and tear, etc.
Paper money can be classified as follows
a) Representative paper money - When the issuing authority keeps cent percent metallic reserves (gold, silver) against the issue of currency notes or paper money, it is called representative paper money.
b) Convertible paper money - When the issuing authority promises to convert currency notes into standard money on demand, it is called convertible paper money. Under this system, a fixed percentage of the value of the currency in circulation is kept in the form of metallic reserves and the remaining part of the currency is covered by government securities.
c) Inconvertible paper money - This is also called 'Fiat Money'. Fiat means government order or command of the sovereign. This money is not convertible into standard money on demand. It is not entirely backed by metallic reserves. This money is declared as a legal tender by government order. As per laws nobody can refuse to accept it. It is obligatory to accept this money for the purchases of goods and services or to discharge debts.
Following are the advantages of paper money.
1) It is easily portable compared to metallic money.
2) It is economical.
3) It requires less storage space.
4) It economizes the use of precious metals.
Limitation of paper money
i) Less durability compared to metallic coins.
ii) Danger of over issue of notes, etc.
4) Credit Money (Bank Money)
It refers to the bank deposits kept by people with banks, which are withdrawable 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.
5) 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.
After discussing the different types of money it is important to know the classification of money on the basis of acceptability. On this basis money is classified into the following categories -
a) Legal tender money.
b) Non-legal tender or optional money.
a) 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 -
i) Limited legal tender money - It is that money which is accepted as legal tender, only upto a certain limited amount.
ii) Unlimited legal tender - It is one which is to be accepted as a medium of payment, upto any amount.
b) Non-legal tender 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 examples of optional money.
From the point of view of the circulation, money is classified into (a) Actual money (b) Money of account.
(a) 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.
(b) 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.
6) Near Money - It indicates those assets which are not perfect medium of exchange though 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.
10.5 Functions of Money :
Money plays many significant roles in modern economy.
Broadly the functions of money can be classified into three categories.
a) Primary functions
b) Secondary functions
c) Contingent functions
A) Primary Functions :
i) Medium of Exchange - The fundamental role of money is to serve as a medium of exchange. This is the most important function of money. By working as a medium of exchange money divides the exchange transactions into two parts, namely sale and purchase. This function of money has solved one of the biggest problems of the Barter System. i.e. lack of double co-incidence of wants. Any commodity or service can be bought with and sold for money. Money represents general purchasing power. A person can sell any commodity today for money and can use the money in future to purchase any commodity or service. Some unique characteristics of money like general acceptability, portability, durability etc. have helped money to work as a medium of exchange.
ii) Measure of Value or unit of account - The value of all goods and services is expressed in terms of money. It is a unit of account. When the value of a commodity is expressed in terms of money, it is called price. It helps us to compare the value of all commodities. By comparing the prices of different commodities, relative values of these commodities can be calculated, e.g., price of a table is ` 2,000 and price of a chair is ` 500. It indicates that the value of a table is equivalent to the value of 4 chairs. Goods and services are quantified in different units. It would have been difficult to express the value of a kilogram of sugar in terms of certain litre of milk or a certain metre of cloth, in the absence of money. This difficulty is overcome when the prices of all these goods are expressed in terms of money which is a unit of account. Every country has a standard money or a monetary unit in terms of which values are expressed and measured e.g. Dollars, Pounds, Yens, etc. In India Rupee is the unit of account. Incomes and expenditures of all kinds, assets and liabilities of all kinds, budgets of the government etc., are stated in terms of money as a unit of account.
B) Secondary Functions :
i) Standard of deferred payments - In the modern economy many transactions take place without instant payments. The debtors make a promise to make payments on some future date. Such future payments are possible because of money. Under Barter System taking loan was easy, but its repayment was difficult because loans were in the form of grains or cattle. Money facilitates lending and borrowings, because the borrowings are in the form of money and the repayment are also in the form of money. Due to general acceptability, stability of value compared to other goods, durability etc., money acts as a standard of deferred payments.
ii) Store of value - Money works as a store of value. Along with satisfaction of present wants, provision for satisfaction of future wants is equally important. It requires savings from the current earnings. Money is a convenient means through which savings can be done easily: According to Lord J.M. Keynes, "money is a link between the present and the future." Money serves as a store of value because money has purchasing power. It can be used to purchase real assets like land, house etc. and financial assets like shares, debentures, bonds, etc.
iii) Transfer of Value - Today with the extension of trade among various countries and organizations it becomes necessary to transfer purchasing power from one place to another. This is easily done by money. Money helps to shift the purchasing power from one place to another e.g. real assets like building or agricultural land from one place can be sold and with the help of that money, building or land can be purchased at some other place.
(C) Contingent/Incidental Functions of Money :
According to Prof. Kinley, money in modern times also performs certain contingent functions. Following are some contingent or incidental functions of money.
i) Measurement and Division of National Income - Money facilitates estimation and distribution of national income. Numerous goods and services are produced in a country during a period of time. When these goods and services are converted in terms of money, calculation of national income becomes possible. Factors of production like land, labour, capital and organisation contribute to national income. All these factors get their respective rewards .like rent, wages, interest and profit in terms of money. Thus, total production and factor prices are easily expressed in terms of money.
ii) Basis of Credit - Modern economy is based on credit. Commercial banks create credit on the basis of their cash holdings. Without the use of money, credit instruments cannot operate. One cannot issue cheque without having a bank balance. Money provides the liquid base of the banking system.
iii) Imparts liquidity to wealth - Money is called the most liquid asset. Money can be easily converted into any asset and any asset can be converted in to money e.g. a person can purchase gold and if he wants, he can sell it and can purchase government bonds, securities etc. Liquidity of money has improved the mobility of capital from a business in loss to a profit making business. It also facilitates transfer of capital from less productive use to a more productive use.
iv) Equalization of marginal utilities and marginal productivities with Price - Prices of goods, services and prices of all factors of production are expressed in terms of money. It helps the consumers to compare marginal utilities of goods with their prices. Based on this comparison consumers can allocate their income on various goods, in such a way that the price of each commodity is equal to its marginal utility.
Producers compare factor prices like rent for land, wages for labour, interest for capital, with marginal productivity (contribution made by additional factor unit to total productivity) of factors of production. The producers try to maximize their profits by equalizing marginal productivity of a factor with its price.
v) 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, budget etc.
Thus, in modern monetized economy money has facilitated production, distribution, saving etc. It encourages international trade, transport, formation of capital market and other financial institutions.
Along with these functions money also performs some other functions like
(a) It helps in the maintainance of the repaying capacity which is called 'guarantee of solvency'.
(b) Money can be used for any purpose according to the priority of an individual or an organization e.g. Money saved by a person to purchase a house in future can be used for higher education of children. Prof. Graham has called this function of money as 'bearer of option'.
(c) It is the base of price mechanism - Prices of all goods and all factors of production are expressed in terms of money. Price mechanism guides important decisions like what to produce how much to produce, how to distribute etc.
When money performs various functions, different qualities or characteristics of money help it to perform these functions. Let us discuss qualities of good money.
10.6 Qualities of Good Money :
Any commodity cannot act as money. A thing which works as money must possess some qualities or characteristics. Following are the qualities of money.
1) General acceptability - The thing which acts as money must be easily accepted by all without hesitation for exchange.
2) Divisibility - It should be divisible into different denominations, e.g., 5 rupees, 10 rupees, 50 rupees, etc.
3) Durability - It should be durable. It should last for a longer period of time e.g. metallic coins are more durable than paper notes.
4) Cognizibility - It must be easily recognizable and distinguishable from other things.
5) Portability - It must be easy to carry from one place to another without any difficulty, expense and inconvenience e.g. paper notes are easily portable. They also possess high value in a small bulk e.g. notes of Rs. 500, Rs. 1000.
6) Homogeneity - The money of same denomination should be of the same size, quality etc.
7) Stability of Value - It must have general stability of value.
Q.1.A) Fill in the blanks with appropriate alternatives given in the brackets.
1) Medium of exchange is ......... function of money. (primary/secondary/contingent/ additional)
2) In the case of ......... coins intrinsic value is less than their face value (token/full bodied/representative/standard)
3) The most liquid asset is .........
(cheque/ money/shares/debentures)
4) Introduction of ......... removed difficulties of barter. (metals/bank/money/shares)
5) In the initial stage of development ......... was used
(credit money/paper notes/ metallic coins/commodity money)
B) Match the following:
Group "A" Group "B"
1) Near Money a) Sea Shells
2) Secondary b) Double function coincidence of
3) Commodity Money money of wants
4) Barter c) Fiat money
5) Legal tender d) Measure of value
e) Bills of exchange
f) Standard of deferred payments
g) Metalic money.
C) State whether the following statements are true or false.
1) Metallic coins are easily portable than paper notes.
2) Token coins are coins whose face value is greater than their intrinsic value.
3) Money facilities estimation of national income.
4) A cheque is a fiat money.
5) Money increases productivity of capital.
Q.2.A) Define or explain following concept.
1) Barter system
2) Double coincidence of wants
3) Money
4) Near money
5) Limited legal tender
B) Give reasons or explain
1) Money works as a store of value
2) Any commodity cannot act as money
3) Barter System had many difficulties
4) Money is the basis of credit.
Q.3.A) Distinguish between –
1) Commodity money and metallic money.
2) Paper money and metallic coins.
3) Full bodied money and token coins.
4) Primary functions of money and Secondary functions of money.
5) Convertible paper money and inconvertible paper money.
B) Write Short Notes –
1) Commodity money
2) Secondary function of money
3) Qualities of good money.
Q.4 Answer the following questions -
1) What are the contingent functions of money?
2) What are the different types of money?
Q.5 State with reasons whether you agree or disagree with the following statements.
1) Barter System did not have any difficulty.
2) Anything can function as money.
3) Money performs various functions.
Q.6 Answer in details -
1) Explain primary, secondary and contingent functions of money
Project :
Study of merits and demerits of plastic money based on experiences of people.
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