MONEY
NOTES
1️⃣ Introduction to Money
In the early stages of economic development, people used the barter system to exchange goods and services. Over time, due to several difficulties associated with barter, money emerged as a modern and efficient medium of exchange.
This chapter aims to explain the evolution, meaning, and importance of money in a modern economy. The following key areas are covered:
- Barter system and its problems
- Meaning and functions of money
- Definitions of money
- Money supply and its measures
- High-powered money
- Important terminology related to money
2️⃣ Barter System and Its Difficulties
🔹 Meaning of Barter System
The barter system is a system in which goods are exchanged directly for goods, without the use of money.
Examples:
- Wheat exchanged for cloth
- A teacher paid in rice or wheat for services
This system existed in a C–C Economy (Commodity to Commodity economy).
C = Commodity
C–C Economy = Economy dominated by barter exchange
🔹 Difficulties of Barter System
(a) Lack of Double Coincidence of Wants
Barter requires that both persons must want each other’s goods at the same time. This condition is known as double coincidence of wants.
Such a coincidence is rare and difficult to find every time, which limits exchange.
(b) Lack of Divisibility
Many goods cannot be divided into smaller units for exchange.
Examples:
- A car cannot be divided to exchange for a scooter
- Animals cannot be divided
This makes the barter system impractical.
(c) Difficulty in Storing Wealth
Wealth was stored in the form of goods such as wheat, rice, or cattle. These goods:
- Are perishable
- Require large storage space
- Involve high transportation costs
Immovable goods like land and houses cannot be stored or transferred easily.
(d) Absence of Common Measure of Value
Different goods have different values, and there was no common unit to measure and compare them.
As a result, determining exchange ratios became very difficult.
(e) Lack of Standard of Deferred Payments
Future payments had to be made in goods under the barter system. This created problems such as:
- Disagreement over quality of goods
- Disagreement over type of commodity
Therefore, credit transactions were almost impossible.
3️⃣ Money – Meaning
Money is anything which:
- Is generally acceptable as a medium of exchange
- Can be converted into other assets without loss of time and value
Money emerged to overcome the limitations of the barter system and to facilitate smooth and efficient exchange in a modern economy.
4️⃣ Functions of Money
Money performs four major functions, which are broadly grouped into:
- Primary Functions
- Secondary Functions
A️⃣ Primary Functions of Money
(i) Medium of Exchange
Money acts as a medium of exchange and eliminates the problem of double coincidence of wants.
Goods and services are exchanged through money. The exchange process involves:
- Sale → Purchase
Liquidity of money refers to the ease with which money can be converted into goods and services.
(ii) Measure of Value / Unit of Account
Money acts as a common measure of value. The values of all goods and services are expressed in monetary terms, known as prices.
“Money acts as a standard measure of value to which all other things can be compared.”
— Geoffrey Crowther
B️⃣ Secondary Functions of Money
(i) Standard of Deferred Payments
A modern economy is largely credit-based, where payments are often made in the future.
Money serves as a reliable standard of deferred payments because it is:
- Generally acceptable
- Stable in value
- Durable and homogeneous
(ii) Store of Value
Money acts as a store of value by allowing wealth to be stored conveniently.
- Savings can be kept without loss in value
- Acts as a bridge between present and future
This function is also known as the asset function of money.
5️⃣ Characteristics / Features of Money
- Durability – Money does not deteriorate or wear out easily and can be used for a long period of time.
- Medium of Exchange – Money facilitates the buying and selling of goods and services by acting as a common medium of exchange.
- Light Weight – Money is easy to carry from one place to another. Paper money is lighter and more convenient than metallic coins.
- Measure of Value – Money expresses the value of goods and services in monetary terms, making comparison easy.
6️⃣ How Money Overcame Drawbacks of Barter
(a) Medium of Exchange
- Money removed the problem of double coincidence of wants.
- Buyers buy goods and services with money.
- Sellers sell goods and services in exchange for money.
(b) Measure of Value
- Money provides a common unit of measurement.
- Prices help in calculating exchange ratios easily.
(c) Store of Value
- Wealth can be stored safely in the form of money.
- Money does not suffer from perishability or storage problems.
(d) Standard of Deferred Payments
- Money made credit transactions possible.
- Future payments can be fixed clearly in monetary terms.
7️⃣ Legal Definition of Money
- Money is anything which is declared by law as a medium of exchange.
- Currency notes and coins are legal tender in a country.
- Nobody can legally refuse them for the settlement of payments.
- Currency is also called Fiat Money, as it derives its value from government authority.
8️⃣ Functional Definition of Money
Money is anything that performs the following functions:
- Medium of exchange
- Measure of value
- Standard of deferred payments
- Store of value
According to the functional definition, money includes:
- Currency notes
- Coins
- Chequeable (demand) deposits
9️⃣ Narrow Definition of Money
The narrow definition of money includes the following components:
- Currency notes
- Coins
- Demand deposits
This definition is also known as the functional definition of money because it performs all the four basic functions of money, namely:
- Medium of exchange
- Measure of value
- Standard of deferred payments
- Store of value
🔟 Broad Definition of Money
The broad definition of money includes the following components:
- Narrow money
- Time deposits / Term deposits
Time deposits are also known as near money because they cannot be used directly for making payments but can be easily converted into money.
1️⃣1️⃣ Money Supply
Money supply refers to the total stock of money held by the public at a point of time.
1️⃣2️⃣ Measures of Money Supply (RBI – 1977)
🔹 Measure M1 (Narrow Money)
Where:
- C = Currency with public
- DD = Demand deposits with banks
- OD = Other deposits with RBI
🔹 Measure M2
🔹 Measure M3 (Broad Money)
🔹 Measure M4
(excluding National Savings Certificates)
1️⃣3️⃣ High-Powered Money
High-powered money refers to the money which is produced and controlled by the Reserve Bank of India (RBI) and the Government.
It includes the following components:
- Currency held by the public
- Cash reserves with banks
1️⃣4️⃣ Words That Matter (Exam Definitions)
- Barter System – Exchange of goods for goods.
- Double Coincidence of Wants – Mutual need of goods by both parties involved in exchange.
- Money – Generally accepted medium of exchange.
- Fiat Money – Money authorized and issued by the government.
- Money Supply – Stock of money held by the public at a point of time.
- Demand Deposits – Deposits which are withdrawable by cheque.
- Time Deposits – Deposits which are withdrawable only after maturity.
- High-Powered Money – Money created by the RBI.
