What is Money, Evaluation of money and What is monetary economics – Studymaterial


Monetary Economics is a branch of economics that provides a framework for analyzing money and its functions as a medium of exchange, store of value and unit of account. It examines the effects of monetary systems including regulation of money and associated financial institutions.


1 Meaning:

Money is anything that is generally accepted as payment for goods and services and repayment of debts and that serves as a medium of exchange. A medium of exchange is anything that is widely accepted as a means of payments. In recent years, the importance of credit has increased in all the countries of the world. Credit instruments are used on an extensive scale. The use of cheques, bills of exchange, etc. has gone up. It should however, be remembered that money is the basis of credit.

2 Definitions

Many economistsdeveloped definition for money. Among these, definitions of Walker and Crowther are given below: “ Money is, what money does” – Walker. “Money can be anything that is generally acceptable as a means of exchange and at the same time acts as a measure and a store of value”.

3 Evolution of Money

Barter System
The introduction of money as a medium of exchange was one of the greatest inventions of mankind. Before money was invented, exchange took place by Barter, that is, commodities and services were directly exchanged for other commodities and services. Under the barter system, buyers and sellers of commodities had to face a number of difficulties. Surplus goods were exchanged for money which in turn was exchanged for other needed goods. Goods like furs, skins, salt, rice, wheat, utensils, weapons, etc. were commonly used as money. Such exchange of goods for goods was known as “Barter Exchange” or “Barter System”.

Metallic Standard

After the barter system and commodity money system, modern money systems evolved. Among these, metallic standard is the premier one. Under metallic standard, some kind of metal either gold or silver is used to determine the standard value of the money and currency. Standard coins made out of the metal are the principal coins used under the metallic standard. These standard coins are full bodied or full weighted legal tender. Their face value is equal to their intrinsic metal value.

Gold Standard

Gold Standard is a system in which the value of the monetary unit or the standard currency is directly linked with gold. The monetary unit is defined in terms of a certain weight of gold. The purchasing power of a unit of money is maintained equal to the value of a fixed weight of gold.

Silver Standard

The silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver. The silver standard is a monetary arrangement in which a country’s Government allows conversion of its currency into fixed amount of silver.

Paper Currency Standard

The paper currency standard refers to the monetary system in which the paper currency notes issued by the Treasury or the Central Bank or both circulate as unlimited legal tender. Paper currency is Monetary Economics not convertible into any metal. Its value is determined independent of the value of gold or any other commodity. The paper standard is also known as managed currency standard. The quantity of money in circulation is controlled by the monetary authority to maintain price stability.

Plastic Money

The latest type of money is plastic money. Plastic money is one of the most evolved forms of financial products. Plastic money is an alternative to the cash or the standard “money”. Plastic money is a term that is used predominantly in reference to the hard plastic cards used every day in place of actual bank notes. Plastic money can come in many different forms such as Cash cards, Credit cards, Debit cards, Pre-paid Cash cards, Store cards, Forex cards and Smart cards. They aim at removing the need for carrying cash to make transactions.

Crypto Currency

A digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a Central Bank. Decentralised crypto currencies such as Bitcoin now provide an outlet for Personal Wealth that is beyond restriction and confiscation.

4 Functions of Money

The main functions of money can be classified into four categories:

Functions of Money

1.Primary Functions

2. Secondary functions

3.contingent functions

4. Other functions.

i) Money as a medium of exchange:

This is considered as the basic function of money. Money has the quality of general acceptability, and all exchanges take place in terms of money. On account of the use of money, the transaction has now come to be divided into two parts. First, money is obtained through sale of goods or services. This is known as sale. Later, money is obtained to buy goods and services. This is known as purchase. Thus, in the modern exchange system money acts as the intermediary in sales and purchases.

ii) Money as a measure of value:

The second important function of money is that it measures the value of goods and services. In other words, the prices of all goods and services are expressed in terms of money. Money is thus looked upon as a collective measure of value. Since all the values are expressed in terms of money, it is easier to determine the rate of exchange between various types of goods in the community.

2.Secondary Functions

i) Money as a Store of value:

Savings done in terms of commodities were not permanent. But, with the invention of money, this difficulty has now disappeared and savings are now done in terms of money. Money also serves as an excellent store of wealth, as it can be easily converted into other marketable assets, such as, land, machinery, plant etc.

ii) Money as a Standard of Deferred Payments:

Borrowing and lending were difficult problems under the barter system. In the absence of money, the borrowed amount could be returned only in terms of goods and services. But the modern money-economy has greatly facilitated the borrowing and lending processes. In other words, money now acts as the standard of deferred payments.

iii) Money as a Means of Transferring Purchasing Power:

The field of exchange also went on extending with growing economic development. The exchange of goods is now extended to distant lands. It is therefore, felt necessary to transfer purchasing power from one place to another.

3.Contingent Functions

i) Basis of the Credit System: Money is the basis of the Credit System. Business transactions are either in cash or on credit. For example, a depositor can make use of cheques only when there are sufficient funds in his account. The commercial bankscreate credit on the basis of adequate cash reserves. But, money is at the back of all credit.

ii) Money facilitates distribution of National Income: The task of distribution of national income was exceedingly complex under the barter system. But the invention of money has now facilitated the distribution of income as rent, wage, interest and profit.

iii) Money helps to Equalize Marginal Utilities and Marginal Productivities: Consumer can obtain maximum utility only if he incurs expenditure on various Monetary Economics commodities in such a manner as to equalize marginal utilities accruing from them. Now in equalizing these marginal utilities, money plays an important role, because the prices of all commodities are expressed in money. Money also helps to equalize marginal productivities of various factors of production.

iv) Money Increases Productivity of Capital: Money is the most liquid form of capital. In other words, capital in the form of money can be put to any use. It is on account of this liquidity of money that capital can be transferred from the less productive to the more productive uses.

4.Other Functions

i) Money helps to maintain Repayment Capacity:

Money possesses the quality of general acceptability. To maintain its repayment capacity, every firm has to keep assets in the form of liquid cash. The firm ensures its repayment capacity with money. Likewise, banks, insurance companies and even governments have to keep some liquid money (i.e., cash)to maintain their repayment capacity.

ii) Money represents Generalized Purchasing Power: Purchasing power kept in terms of money can be put to any use. It is not necessary that money should be used only for the purpose for which it has been served.

iii) Money gives liquidity to Capital: Money is the most liquid form of capital. It can be put to any use.

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