Monetary Economics: Functions of Money.pdf

Unit - I: Functions of money.
Barter system - difficulties – Evolution of Money – functions - significance– classifications – role of money in capitalist, socialist and mixed economy – Evils of money.

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Dr.U.Ramesh
Unit - I: Functions of money.
Barter system - difficulties – Evolution of Money – functions - significance– classifications –
role of money in capitalist, socialist and mixed economy – Evils of money.
BARTER SYSTEM: -
The direct exchange of one commodity or service for another without the use of money is
termed "Barter" in economics. Barter system is that in which no money exist. In other words
it is moneyless economy up to some extent it is still available in our villages. The village,
Blacksmith and Carpenter usually receive his reward in terms of wheat from the farmers.
Barter is workable in backward as well as advanced countries. Now a days due to exchange
difficulties some advanced countries are entering into a barter deal with other countries. Now
this system has been given up by the civilized world due to the following reasons.
DIFFICULTIES OF BARTER SYSTEM: -
Following are the main defects of this system:
1. Lack of Double Coincidence of Wants: -
The direct exchange of one commodity for another requires direct satisfaction of both the
parties. So the main disadvantage of this system is the lack of double coincidence of wants.
For example one cow would be exchanged for four sheep. It is necessary that a person with
the cow should find the man who wants to exchange sheep with the cow. So arranging for
such an exchange would be very difficult.
2. Lack of Common Standard of Value:-
All the goods which are be exchanged are not of the same value, so it is very difficult to
determine the ratio of exchange between the different goods.
3. Lack of Subdivision:-
In case of goods which are indivisible the value loss will be suffered. For example, if the
owner of a cow wants to purchase a hen then it will be not possible for him to give a small
part of cow to the owner of a hen. In this case he will suffer a loss.
4. The Difficulty In Strong Wealth:-
It is very difficult to store goods particularly perishable goods for a long period. They loose
their value as time passes.

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5. Difficulty For Future Payments :-
Under this system it is very inconvenient to lend goods to other people. With the lapse of
time the value of goods may fall. So one would like to suffer a loss.
6. Difficulties For Finance Minister:-
Under barter system, goods can not be collected as a tax, because these can not be kept in a
store for a longer period.
7. Difficulties For Transfer of Wealth:-
Under this system transfer of wealth also becomes a problem for the people. For example one
person wants to take one thousand cow from Gujrat to Ahmadabad, how much difficulty he
would feel?
Now by the use of money all these difficulties have been removed.
8. Lack of Specialization:-
Under the barter system a high degree of specialization is not possible. A person cannot yet
the skill of specialization the particular field as we find in the present system of production.
EVOLUTION OF MONEY
Money has evolved through various stages. The stages are as follows:
1. Commodity Money
In the ancient trade or barter system, any commodity that was demanded or selected with the
consent of both parties and has some value was used as money. For example, wheat, clothes,
fur, metal, salt, etc., were used as money. But after the introduction of commodity money,
gold or silver coins were used as money. Gold coins were valuable, as they can be used in
exchange for goods & services. However, as gold itself was valued and has other uses also,
commodity money gave rise to the next stage of money; i.e., representative money.
2. Metallic Money
With the progress of the trade, commodity money was converted into metallic money.
Metals like silver, copper, gold, etc., were commonly used as they are easy to use and their
quantity can be easily determined. Metallic money was the main type of money throughout a
huge part of recorded history. But everything has both positive and negative aspects, no doubt
metallic money helps with easy exchange of goods & services, but it gave rise to some
problems also, which lead to next stage of evolution of money.

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3. Paper Money
It was very difficult and unsafe to carry gold and silver coins from place to place, therefore,
paper money was invented. The invention of paper money was the most important stage of
money evolution. It is controlled and regulated by the Reserve Bank of India (the Central
Bank). In the present scenario, currency notes or paper money captures a huge part of money
issued by the central bank, and most of the transactions are carried out with the help of paper
money.
4. Credit Money
Credit money was invented along with paper money, people keep a part of their cash or
savings as bank deposits and withdraw them with the help of cheques as per their needs or
requirements. The cheque (credit money or bank money) is not money in reality but performs
all the functions similar to money.
5. Plastic Money
Plastic money is the latest type of money in the form of debit and credit cards. The main aim
of plastic money is to reduce the need of carrying cash everywhere to make transactions.
Currently, plastic money is used largely by people, which reduces the risk of carrying a large
amount of cash for making transactions.
FUNCTIONS OF MONEY
Definition of 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 money, this is a legal tender and hence there is a legal compulsion on citizens to accept
it.

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Functions of money can be broadly categorised into the following two types:
(a) Primary functions
(b) Secondary functions
(a) Primary functions


i) Medium of exchange: It means that money can be used to make payments for all the
transactions of goods and services. A buyer can buy goods through money, and a seller can
sell goods for money. It is an essential function of money.
ii) Measure of value: Money serves as a measure of value. The value of all goods and
services is expressed in terms of money.
(b) Secondary functions


i) Standard of deferred payments: It means that money acts as a ‘standard’ for making
future payments. It has made deferred payments much easier than before. Example: When
we borrow money from somebody, we have to return both the principal as well as the
interest amount in the future. Money is a convenient mode of calculation and payment of
interest amount to be paid in the future. This function has facilitated borrowing and lending.
It has also led to the creation of financial institutions.
ii) Store of value: A store of value implies a store of wealth. Money can be easily stored for
future use. It is the most convenient and economical means to store earnings and wealth.
iii) Transfer of value: Money also serves for transfer of value. It facilitates buying and
selling of goods not only in the domestic country but also in other parts of the world.
SIGNIFICANCE OF MONEY
Money is derived from the Latin word Moneta, which is another name for the Goddess Juno
of Rome. The first mint was established in Rome in the temple of the Goddess Juno or
Moneta. Money cannot be explained only in terms of the matter it embodies, such as metal
or paper. It should be explained by the purpose or use it provides. Money performs four
primary functions: medium of exchange, measure of value, store of value, and standard

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for deferred payments. Therefore, anything that is commonly accepted as a medium of
exchange, a measure of value, a store of value, and a standard for deferred payments is
referred to as Money. In general, Money refers to Notes, Coins, and Bank-cheques.
However, economists continue to disagree on this point.
Definitions of Money
It is impossible to provide an undisputed, widely accepted definition of money. Usually, one
of the two approaches for the term “money” is used:
1. Money is defined as anything that can be used to pay for goods and services or to
settle debts.
2. Money is defined as anything that serves as a means of trade, a measure of value, and
a store of value.

Money is highly significant in all fields of economics. According to Marshall, “Money is the
pivot around which the whole economic science clusters.” The importance of money in
various economic fields is as follows:
1. Importance in Consumption:
A consumer gets his income in the form of money. He can use the money to buy the products
and services he desires. According to the law of equi-marginal utility, the consumer spends
his income in a way that maximises his level of satisfaction. A customer should spend his
money in such a way that the ratio of marginal utility to commodity price is the same for all
commodities he buys.
2. Importance in Production:
Money is also crucial in the field of production. A producer will like to manufacture only the
things that will generate the most profit. However, estimating profit is impossible unless the
producer knows the prices of various goods, their suppliers, and the cost of production.
Money is an important variable for information about the demand for commodities and the
supply of goods. Money promotes large-scale manufacturing by facilitating specialisation and
the division of labour. The ratio of marginal productivity to factor price should be the same
for all of the production factors in order to maximise the production of given resources
3. Importance in Exchange:
Money has made the process of exchange much simpler by eliminating the demerits of the
barter system of exchange. Money is the basis of the price mechanism. Cost and revenue
estimates are determined in terms of money. Money has facilitated future transactions,

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contributing to the growth of both domestic and international trade. The creation of credit,
which is based on money, also encouraged exchange. Money has significantly expanded
trade. In fact, money is the foundation of modern market organisations.

4. Importance in Trade:
Money has improved both domestic and international trade. Trade was limited under the
Barter System due to several challenges. The invention of money encouraged large-scale
production. Large markets are required for large-scale production. In this situation, various
kinds of money, such as bills of exchange, promissory notes, and drafts, play a significant
role. Money has enabled the establishment of money markets with a view of enhancing trade.
5. Importance in Distribution:
Money promotes the allocation of national income among various factors of production. In
terms of money, it is simple to pay pent for the use of land, interest for capital, salaries for
labour, and profit for entrepreneurship. It was difficult to calculate factor shares under the
Barter System. With money and production, rewards can be distributed in accordance with
a contribution to total output. Money has proven to be a significant instrument in ensuring an
equitable distribution of national income.
6. Importance of Public Finance:
Public finance is a significant phenomenon for any welfare state in the modern
age. The important sources of finance for the state are taxes, public debt, deficit financing,
and so on. All of these are obtained only in the form of money. Money serves as a useful
instrument for achieving the objective of maximum social welfare. The
Government establishes a budget for the upcoming year’s expected revenue and expenditure.
All of these estimations are monetary in nature. As a result, money is crucial in the
preparation of the Government Budget.
7. Capital Formation:
It was not possible to save and invest in terms of goods under the Barter System. Money has
made it possible to save and invest. Saving refers to the part of an individual’s income that is
not spent. Savings, when invested, result in capital formation. Capital formation enhances
the productive capacity of the nation. Accordingly, increased production leads to economic
development.
8. Solution to Central Economic Problems:

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Money has facilitated the right solution to the central problems of the economy; i.e., what to
produce, how to produce, and for whom to produce. Money facilitates the continuous flow of
goods and services.


9. Basis of Credit:
The trade is based on credit in the modern age. Credit creation was not possible in the
absence of money, as a store of value of money has facilitated credit creation.
10. Index of Economic Development:
There are some central basic elements of economic development, like national income, per
capita income, and so on. All of these elements can be simply determined by the money form.
If the country’s national and per capita income has been increasing and there is equality in
income distribution, it may be properly believed that economic development is taking place.
ROLE OF MONEY IN CAPITALIST, SOCIALIST AND MIXED ECONOMY
The role of money in different economic systems, such as capitalist, socialist, and mixed
economies, can vary in terms of its functions and significance. Here is a general overview of
the role of money in each of these economic systems:
1. Capitalist Economy:
 In a capitalist economy, money plays a central role as a medium of
exchange, a unit of account, and a store of value. It facilitates
transactions, simplifies the process of buying and selling goods and
services, and serves as a common measure of value.
 Money in a capitalist economy also serves as a signal of value and
scarcity. Prices are determined by the interaction of supply and
demand in markets, and money helps to allocate resources
efficiently based on consumer preferences and profitability.
 Capitalist economies rely on the profit motive and private ownership
of the means of production. Money is a key driver of economic
activity, investment, and innovation in such systems.
2. Socialist Economy:
 In a socialist economy, the role of money is often more limited
compared to a capitalist economy. The emphasis in socialism is

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typically on collective ownership of the means of production and
central planning of the economy.
 Money may still function as a medium of exchange and a unit of
account in a socialist economy, but its role in resource allocation and
distribution is often less prominent. Instead of market forces
determining prices and resource allocation, central planning
authorities may play a larger role in decision-making.
 Socialist economies may place greater emphasis on social welfare,
equity, and public goods, which can influence the role and
distribution of money within the economy.
3. Mixed Economy:
 In a mixed economy, which combines elements of both capitalism
and socialism, the role of money can vary depending on the specific
mix of market mechanisms and government intervention.
 Money continues to serve as a medium of exchange, a unit of
account, and a store of value in a mixed economy. Prices are often
determined by market forces, but the government may also intervene
to address market failures, regulate industries, or provide public
goods and services.
 In a mixed economy, the government may use fiscal and monetary
policy tools to influence economic activity, stabilize the economy,
and promote certain social objectives. Money plays a crucial role in
facilitating these policy interventions.
Overall, while the functions of money as a medium of exchange and a unit of account are
common across different economic systems, the extent to which money influences resource
allocation, distribution, and economic decision-making can vary significantly in capitalist,
socialist, and mixed economies.
EVILS OF MONEY

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