Money and Functions of
Money
Dr. Ronismita Mishra
Introduction to Money
• Money, in simple terms, is a medium of exchange. It is
instrumental in the exchange of goods and/or services.
• Further, money is the most liquid assets among all our assets.
It also has general acceptability as a means of payment along
with its liquid nature.
• Usually, the Central Bank or Government of a country creates
and issues money. Also called cash, this is a legal tender and
hence there is a legal compulsion on citizens to accept it.
• Credit money is another form of money which the banks
create through loan transactions.
Money is What Money does – What is
Money?
• Money acts as a legal tender for any type of exchange and transaction.
Buyers can purchase goods or services from the seller in exchange for
money. The presence of money in the economic market makes the
transactions taking place easier as in the other scenario; one will have to
use barter for the transactions.
• According to a barter system, to purchase a good or service from a
seller, the buyer has to offer them an equal value of the good or
commodity. Besides, the transaction will take place only when a seller is
interested in the offered product. Thereby, the probability of this event
occurring is quite low, and hence completing transactions would be
difficult.
• Money eliminates such conflicts from occurring and helps in the
exchange method. This makes the transaction process convenient and
widely accepted by all on an international platform.
Need Money? – Visualize the Scenario
• Let’s take a scenario to understand this better.
Scenario:
Rohan has 50 liters of Milk supply obtained from his cattle. Now, he
can either utilize the whole amount or store it for future use. But,
milk is a perishable item, and hence they won’t be able to store it
for a longer time and use it themselves. In such a case, they can
exchange this surplus milk in exchange for a good or service of
equal value. However, the task of finding a buyer who has a product
that piques Rohan’s interest as well can be tedious. In this case,
having money for the exchange of milk is the best solution to his
problem as he can use the acquired money anytime to purchase an
equal-value good or service that he needs.
Functions of Money
There are many static and dynamic functions of money as follows:
Static Functions of Money
These functions are:
• A medium of Exchange – In an exchange economy, money plays an
intermediary role. It makes the exchange system smooth and convenient.
• A measure of Value – The value of a product or service is determined on the
basis of the money needed for its possession. This helps in making the
exchange a mutually profitable activity.
• The Standard of Deferred Payments – Money plays an important role in
lending and borrowing. Money is taken as a loan and repaid after a time-gap.
• Store of Value – You can store the purchasing power of money and keep a
part of it for future use – monetary savings. You can use your current income
for current consumption as well as future consumption through savings.
Dynamic Functions of Money:
These functions are:
• Money can activate idle resources and put them into
productive channels.
• Therefore, it helps in increasing output, employment, and also
income levels.
• Further, it helps in converting savings into investments.
• The creation of new money governments of modern
economies can spend more than what they earn.
Value of Money
• The value of money simply implies its exchange value. It
means the number/amount of goods and/or services that you
can obtain in exchange for a single unit of money.
• Further, the value of money is inversely proportional to the
price of goods/services. Therefore, if the price level increases,
the value of money decreases and vice-versa.
Forms of Money
• We can classify the total money supply of an economy into
two broad groups – Cash Money and Credit Money, including
all other financial assets. The degree of money-ness of
different assets is different.
The Components of Money Supply
The components of the money supply are as follows:
• Paper Money and Coins – The Central Bank or Government issues these as
Currency. Further, they have a 100% acceptance as a means of payment. The
acceptance is based on a ‘promise to pay the bearer’ gold and/or foreign
exchange in return.
• Demand Deposit – A bank has a legal obligation to pay money on demand. The
money-ness is highest in currency and demand deposits.
• Near Money or Money Substitute – A commonly used Near Money is a bank
cheque. many people accept it as a means of payment. However, there is no
legal compulsion behind their acceptance.
• Term deposit – This is less liquid than a demand deposit as the individual
cannot use it before a fixed period of time.
• Other Financial Assets – Many non-banking financial intermediaries issue these
assets.
