Question 5:- What are the basic functions of money?
Explain in detail the
derivative functions of money.
Money
The word "money" is believed to originate from a temple of Hera, located on
Capitoline, one of Rome's seven hills. In the ancient world Hera was often
associated with money. The temple of Juno Moneta at Rome was the place
where the mint of Ancient Rome was located.
The name "Juno" may derive from the Etruscan goddess Uni (which means "the
one", "unique", "unit", "union", "united") and "Moneta" either from the Latin word
"monere" (remind, warn, or instruct) or the Greek word "moneres" (alone,
unique).
(Reference: "Online Etymology Dictionary". [Link].
Functions of Money
There have been many historical disputes regarding the combination of money's
functions, some arguing that they need more separation and that a single unit is
insufficient to deal with them all. One of these arguments is that the role of
money as a medium of exchange is in conflict with its role as a store of value: its
role as a store of value requires holding it without spending, whereas its role as a
medium of exchange requires it to circulate. Others argue that storing of value is
just deferral of the exchange, but does not diminish the fact that money is a
medium of exchange that can be transported both across space and time. The
term 'financial capital' is a more general and inclusive term for all liquid
instruments, whether or not they are a uniformly recognized tender
Money is a matter of functions four, a medium, a measure, a standard, a store."
That is, money functions as a medium of exchange, a unit of account, a standard
of deferred payment, and a store of value.
The four broad functions of money can be described as follow:1) Primary functions
A) Money as a unit of account:A unit of account is a standard numerical unit of measurement of the market
value of goods, services, and other transactions. Also known as a "measure" or
"standard" of relative worth and deferred payment, a unit of account is a
necessary prerequisite for the formulation of commercial agreements that involve
debt. To function as a 'unit of account', whatever is being used as money must
be:
Divisible into smaller units without loss of value; precious metals can be
coined from bars, or melted down into bars again.
Fungible: that is, one unit or piece must be perceived as equivalent to any
other, which is why diamonds, works of art or real estate are not suitable
as money.
A specific weight, or measure, or size to be verifiably countable. For
instance, coins are often made with ridges around the edges, so that any
removal of material from the coin (lowering its commodity value) will be
easy to detect.
B) Money as Medium of Exchange.
The phenomenon of money presupposes an economic order in which production
is based on division of labor and in which private property consists not only in
goods of the first order (consumption goods), but also in goods of higher orders
(production goods). In such a society, there is no systematic centralized control
of production, for this is inconceivable without centralized disposal over the
means of production. Production is "anarchistic." What is to be produced, and
how it is to be produced, is decided in the first place by the owners of the means
of production, who produce, however, not only for their own needs, but also for
the needs of others, and in their valuations take into account, not only the usevalue that they themselves attach to their products, but also the use-value that
these possess in the estimation of the other members of the community. The
balancing of production and consumption takes place in the market, where the
different producers meet to exchange goods and services by bargaining together.
The function of money is to facilitate the business of the market by acting as a
common medium of exchange.
2) Derivative functions of Money
a) Money as standard of deferred payment
Economic agents, when engaging in contracts to make deferred payments,
frequently fix the value of such payments in units of money rather than in
units of non-money goods. The practice is so common that the use of money as
a standard of deferred payment has, along with its use as medium of exchange,
been traditionally regarded as one of its major economic functions. But in a
world where future prices are uncertain the fixing of deferred payments in
units of money and units of goods are clearly not equivalent, and this common
use of the medium of exchange as a standard of deferred payment is somewhat
remarkable. In this paper we examine the choice of standard of deferred
payment by rational individuals, and attempt to provide a theoretical link
between the use of a good as medium of exchange and its use as standard of
deferred payment. We are asking whether the use of money as standard of
deferred payment is more than just a convenient adjunct to its use as medium
of exchange.
Consider a hypothetical loan agreement between two individuals. One individual,
the lender, gives another individual, the borrower, a quantity of money or goods
in the current period in return for a promised deferred payment in some future
period. A well-defined loan agreement must specify what object or good will be
transferred from the borrower to the lender in the future, and how the quantity of
that object or good transferred will be determined.
We shall refer to the object or good transferred as the means of payment of the
loan. It may, for example, be money, a single good or service, or a standard
combination of goods such as equal numbers of apples and oranges. We shall
not require the agents to fix in advance the quantity of means of payment to be
transferred, but allow them to agree upon rules for determining the quantity to be
transferred once future prices are known. Specifically, we require them to agree
upon a fixed bundle of goods to be purchasable with the deferred
payment. We refer to this fixed bundle as the standard of deferred payment for
the loan. The means of payment and standard of deferred payment need not be
the same good or collection of goods, and the considerations relevant to the
choice of each are somewhat different.
B) Store of value:A billion here, a billion there and pretty soon it adds up to real money.
To act as a store of value, a commodity, a form of money or financial capital
must be able to be reliably saved, stored, and retrieved - and be predictably
useful when it is so retrieved. This is distinct from the standard of deferred
payment function which requires acceptability to parties one owes a debt to, or
the unit of account function which requires fungibility so accounts in any amount
can be readily settled. It is also distinct from the medium of exchange function
which requires durability when used in trade, and a minimum of opportunity to
cheat others.
When currency is stable, money can serve all four functions. When it isn't, such
as during times of hyperinflation or when complex and volatile forms of financial
capital are involved, it becomes important to identify alternative stores of value,
of which common ones are:
real estate - actual deeds in protectible land
gold - once the basis of the gold standard
silver - once the basis of the silver standard
precious stones, and precious metals
collectibles, e.g. original art by a famous artist or antiques
livestock (see African currency)
While these items may be inconvenient to trade daily or store, and may vary in
value quite significantly, they rarely or never lose all value. This is the point of any
store of value, to impose a natural risk management simply due to inherent
stable demand for the underlying asset. It need not be a capital asset at all,
merely have economic value that is not known to disappear even in the worst
situation. In principle, this could be true of any industrial commodity, but gold and
precious metals are generally favored because of their demand and rarity in
nature, which reduces the risk of devaluation associated with increased
production and supply.
References:
1) [Link]