Note on Concept, Function and Role of Money

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Concept of Money

Before the introduction of money, the exchange was carried out on the basis of exchange of goods and services directly. This system is known as barter system. It is a moneyless economic system which involves direct exchange of goods and services with other goods and services.

source:www.libertyholidays.com
source:www.libertyholidays.com

The system in which the goods and commodities are exchanged in terms of other goods and commodities in which double coincidence of wants are required. In a barter system, if a good or service is to be bought or sold, then it is to be exchanged with other good or service. For example: If Sita wants some utensils, then she must find who have them and that person should be willing to trade the utensils for something Sita has. Such types of exchange were very difficult.

To overcome the difficulties, monetary system was introduced and is in practice till date. In this system, goods and services are exchanged in terms of money. For example: If Sita needs utensils again, she will simply go to the owner and exchange the utensils in terms of money. In this system, the double coincidence of wants is not necessary. It is commonly used in almost each and every part of the world. It is much easier than the barter system.

Functions of Money

Source: banking992.blogspot.com
Source: banking992.blogspot.com

There are many functions of money and it can be used for different purposes. However, the functions of money are broadly classified into three categories. They are primary functions, secondary functions and contingent functions. They are briefly described below:

Primary Functions

Under primary functions, the functions of money are given below.

  1. Medium of exchange:

Money is used as medium of exchange. It is used in buying and selling of the goods and services. It makes the exchange of goods and services efficient by facilitating multiple exchanges of goods and services with less time and efforts.

  1. Measure of value:

It is another important function of money. In a barter system, there wasn’t common measure of value so the value of different kind of goods could not be compared with each other. Money can be used as a measure of value for different goods and services. Individuals find it convenient to use the monetary units as a measuring unit.

Secondary Functions

The secondary functions of money are described below:

  1. Store of value:

An important secondary function of money is a store of value of any goods and services. It is a convenient form to store wealth. Money is a medium in which people wishes to hold the wealth. It increases the purchasing power.

  1. Standard of deferred payments:

It is one of the important functions of money as it can be used as standard of the deferred payments. Deferred payments are known as those payments which are to be made in the future. Money is used as a standard of deferred payments because of which borrowing and lending have become easier.

  1. Transfer of value:

Another important function of money is transfer of value. It helps to transfer the value of the assets, properties and also the income of the person to another person. It also had made the transfer or transaction of goods and services simpler . For example, it is easier to transfer money from Kathmandu to Biratnagar.

Contingent functions

  1. Calculation of national income/ National income accounting:

Money helps in national income accounting and also helps to calculate national income. Money helps to distribute the national income among the public. It helps in the calculation and then distribution of the national product through the system of wages, rent, interest, and profit.

  1. Maximization of the Satisfaction:

It is another important function of money. It helps to maximize the benefits of the consumers. A consumer maximizes the satisfaction by comparing the prices of each good or services with its MU (Marginal Utility).

  1. Basis of credit:

Another important function of money is the basis of credit. Credit is an important aspect of the modern economic system and also money constitutes the basis of the credit. The bank creates credit on the basis of the deposits made by people on the bank.

  1. Liquidity of the wealth:

Liquidity means the transferability of any kind of property from money to wealth or vice versa (i.e. wealth to money). Money imparts liquidity to various forms of the wealth.

Forms /Types /Kinds of money

source:www.iaspaper.net
source:www.iaspaper.net

Money is generally divided into 4 categories. They are briefly described below:

  1. Commodity money

In Barter system, various commodities were used as the medium of exchange. Goods or commodities were exchanged in terms of goods or commodities. Commodity money lacked basic features of good money like general acceptability, stability, etc. So, commodity money is discarded in the monetary system.

  1. Metallic money

Metallic money is known as the money made up of metals like gold, silver, copper, and iron. It is in the form of monometallic and bimetallic. Monometallic is made without mixture of metal, i.e. pure gold or pure silver money whereas bimetallic is made from a mixture of gold and silver.

There are two types of metallic money. They are given below:

  • Standard or full bodied money:

Standard or full bodied money are the coins with definite weight and purity like the gold and silver coins. They are the kind of valuable money. The face value is equal to the intrinsic value. It doesn’t lose its value even it is melted.

  • Token money:

The money which is made up of inferior metals is known as token money. It is also known as subsidiary money. The value of token money is higher than the intrinsic value. It loses its value when its melted.

  1. Paper money

The money which is made up of paper is known as paper money. The face value of paper money is more than its intrinsic value. Higher the face value of paper money, greater is the facilities in the transaction. It is easier for handling and acceptable. Paper money can be divided into following two parts:

  • Representative or convertible money:

Representative money is the type of paper money that is represented by precious metals like gold and silver. Since they can be converted into gold in case of requirement, they are also known as convertible money.

  • Fiat or Inconvertible Money:

Fiat money is known as the money which is issued by the central authority or Government without maintaining cent percent gold reserves. Inconvertible paper money is issued in the case of an emergency like war, deflation or crisis.

  1. Bank money/credit money

The cheque on demand deposit is known as bank money. It is also called as optional money because no one can be forced to accept this type of money.

The cheque drawn on demand or current deposit of bank, bills of exchange, promissory notes, drafts, and letter of credit are the examples of credit instruments used in the money market.

Role of money

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source:slideplayer.com

In Production: Money facilitates production by stimulating savings and investment. It helps in capital formation and mobilizing capital.

In Distribution: It plays an important role in the field of distribution of national income as wage, rent, interest.

In Consumption:Money enables a consumer to maximize his satisfaction. People use the money to buy goods.

In Exchange: Money possess the purchasing power and serves as a medium of exchange.

Public Finance: Government receives revenue such as tax, fines, etc. in the form of money.

Value of Money

The value of money is the purchasing power of money. It refers to the number of goods and services that the money can buy. Larger the amount of goods and services money can purchase, the larger will be the value of money. And lower the amount of goods and services the money can purchase the lower the value of money will be.

According to Robertson, the value of money means "The amount of things in general which will be given in exchange for a unit of money."

In words of Keynes, "Money, as such has no utility except what is derived from its exchange value, that is to say, from the utility of the things which it can buy."

The purchasing power of the money is inversely related to the price level. When the price level is high the purchasing power is low and when the price level is low, the purchasing power of money is high.

Symbolically, Vm = \(\frac{Vm}{1}\)

Vm = \(\frac{Vm}{1}\)

Where,

Vm = Value of Money

P = Price Level

Thus, the value of money cannot be measured in absolute term. The value of money is a relative concept which varies from person to person according to types of goods.

(Jha, Bhusal and Bista)(Karna, Khanal, and Chaulagain)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

  1. Money is broadly classified into three functions. They are primary functions, secondary functions and contingent functions. 
  2. Money can be categorized under four parts as Commodity money, Metallic money, Paper money, and Bank or credit money .
  3. The functions of money are broadly classified into three categories. They are primary functions, secondary functions and contingent functions. 
  4. An important secondary function of money is a store of value of any goods and services. 
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