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Functions and Supply of Money Explained

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12 views3 pages

Functions and Supply of Money Explained

Uploaded by

RISHIKA
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

CHAPTER - 5

MONEY
Barter system of exchange
Barter system of exchange is a system in which goods are exchanged for goods.
Barter Economy
An economy, in which commodities are exchanged for commodities, is called a ‘Barter
Economy’ or ‘C – C Economy’.
Money
Money is anything which is generally accepted as a medium of exchange, measure of value,
store of value and means for standard of deferred payment.
Functions of money
Functions of
Money

Standard of
Medium of Measures of
Deferred Store of Value
Exchange value
Payments

(1) Medium of Exchange:


Money, as a medium of exchange, means that it can be used to make payments for all
transactions of goods and services. It is most essential function of the money. Money
has the quality of general acceptability. So, all exchanges take place in terms of money.
 This function has removed the major difficulty of lack of double coincidence of
wants in barter system.
 Use of money allows purchase and sale to be conducted independently of one
another.
 This function of money facilitates trade and helps in conducting transactions in an
economy.
 Money has no power to satisfy human wants, but it commands power to purchase
those things, which have utility to satisfy human wants.
(2) Measures of Value (Unit of Value):
Money as a measure of value means that money works as a common denomination, in
which values of all goods and services are expressed.
 Money is a standard unit of quoting prices of goods and services. Due to this reason,
it is regarded as ‘Unit of Account’.
 When we express the value of commodity in terms of money, it is known as price.
After knowing the prices of goods and services, it is not difficult to determine
exchange ratio between them.

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 This function makes possible the keeping of business accounts. It would be
impossible to keep the business accounts unless all business transactions are
expressed in money.
(3) Standard of Deferred Payments:
Money serves as a standard of deferred payment. Deferred payments refer to payments
made in future.
In a modern economy, a large number of transactions involve future payments which
can easily be stated in terms of money. Suppose you borrow a sum of ₹ 20,000 at 10 %
interest per annum for one year. It means that you promise to pay ₹ 22,000 (₹20,000 as
principal and ₹2,000 as interest) after one year.
This function of money is significant because:
 This function of money makes possible the credit transactions to happen when
payments are not to be made immediately.
 Money as a standard of deferred payments has simplified the borrowing and lending
operations.
 This function leads to creation of financial institutions which is very basic
infrastructure for modern business.
(4) Store of Value:
Store of value means store of wealth for future use i.e. shifting of purchasing power
from the present to future. It provides security to individuals to meet contingencies,
unpredictable emergencies and to pay future debts. Money has made the storing of
wealth most convenient. Under barter system, it was difficult to use goods as a wealth
due to perishable nature and high cost of storage.
Money as store of value has the following advantages:
 Money is available in the fractional denomination from ₹ 1 to ₹ 2,000.
 Money is easily portable. So, it is easy and economical to store money as its storage
does not require much space.
 Money has the merit of general acceptability. So, it can be easily exchanged for
goods at all times.
 Savings in terms of money are much secured than in terms of goods.
Money Supply.
Money supply refers to total volume of money held by public at a particular point of
time in an economy.
Components of money supply
(1) Currency notes and coins with the public: It consists of paper notes and coins of
different denominations held by public. It is most liquid of all assets. Any currency held
with the government and banks is not to be included.
(2) Net demand deposits of commercial banks: Demand deposits are those deposits, which
can be encashed (withdrawn) on demand by the account holder from bank (saving
account and current account deposits) by issuing cheques at any time.

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(3) Other deposits with Reserve Bank of India (RBI): It includes demand deposits held by
RBI on behalf of foreign banks and government, public financial institutions (like
NABARD) and international financial institutions (like World Bank, IMF) etc.
It does not include deposits of Indian Government and commercial banks with RBI.

Common questions

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Money's 'store of value' function implies enhanced security and liquidity compared to goods. Unlike perishable goods, money retains its value over time, offering a safer savings vehicle. This liquidity means individuals and businesses can quickly convert stored money into goods and services, crucial for addressing unforeseen financial needs or investment opportunities .

The function of money as a standard of deferred payments has led to the establishment of financial institutions that facilitate loans and credit systems essential for economic growth. These institutions rely on money for consistent valuation and risk management in deferred transactions, which are pivotal in modern business environments .

Without money as a store of value, maintaining stable wealth over time becomes difficult, leading to increased uncertainty and reduced economic security. Goods may deteriorate or lose value, impeding wealth accumulation and thus discouraging saving and long-term planning. Trade and economic stability would likely suffer, as future purchasing power would be less predictable .

As a 'measure of value', money provides a common denominator for pricing goods and services, simplifying the process of determining and comparing values. This uniform pricing mechanism facilitates trade by preventing the complexities of directly comparing different goods as in barter. It makes it possible to keep accurate business accounts, contributing to the smooth operation of economic transactions .

Money serves as a medium of exchange which eliminates the reliance on a double coincidence of wants inherent in a barter system. In a barter system, both parties need to have what the other desires simultaneously, whereas money allows transactions to be conducted independently. This makes trade more flexible and efficient .

Money as a standard of deferred payments facilitates credit transactions, allowing businesses and individuals to engage in contracts and agreements involving future payments. This function underpins lending and borrowing activities, which are essential for economic growth. It also supports the existence of financial institutions that provide necessary business infrastructure .

The 'store of value' function of money offers several advantages over goods in a barter system: money does not spoil or degrade over time unlike many goods, is easily storable and portable, and maintains a more stable value. Money's general acceptability means it can be quickly converted into goods or services when needed, providing security for future needs .

The money supply includes several components: currency notes and coins with the public, net demand deposits of commercial banks, and other deposits with the RBI. Currency and demand deposits provide immediate liquidity, which is crucial for facilitating daily transactions. Other RBI-held deposits ensure a stable national and international banking structure, supporting foreign and domestic economic stability .

Money as a unit of account allows prices to be uniformly stated and compared, facilitating effective bookkeeping and financial planning. Businesses rely on consistent valuation for inventory management, profit analysis, and setting financial strategies. This function underpins accurate business accounts, enabling firms to make informed decisions and maintain operational efficiency .

Money provides a standard unit for deferring payments, allowing precise calculation of future sums due, including interest. This precision and the ease of dividing units make it more effective than commodities for future transactions. Unlike goods, which can fluctuate in quality and availability, money provides a reliable and standardized value .

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