Functions of Money

What Is Money?

Money is a commodity widely acknowledged as a vehicle of economic exchange. It's the legal tender, a medium of exchange for commodities and services used by individuals, firms, and organizations to acquire these resources. 

It is the fundamental method for expressing prices and values; it moves freely from person to person and country to country, facilitating trade; and it is the primary measure of wealth.

Throughout history, money has taken many diverse forms. Some examples include cowry shells in Africa, large stone wheels on the Pacific island of Yap, and beaded strings known as wampum used by Native Americans and early settlers in the United States. 

Economists believe that the development of money ranks with the great achievements of ancient times, such as the wheel and the inclined plane, but how did money evolve? 

Early types of currencies were frequently commodity money, meaning its worth was derived from the valuable element it was manufactured from. Gold and silver coins are examples of commodity money. 

Gold coins were important because they could be exchanged for other commodities or services and because gold itself was precious and had other applications. Commodity money gave way to the next stage of money, representing money.

Characteristics of Money 

Money should be fungible, durable, portable, identifiable, and stable to be most helpful. The level of complexity in society influences the qualities of what acts as money.

A basic economy with few commodities and services may have a different type of money that would not work in a more complicated society. However, in a contemporary economy, several common features are crucial for whatever functions as money. 

1. Durability 

Durability is defined as an item's ability to survive all difficulties while remaining intact and useful after a lengthy period of use. For example, the ability of money to serve as a medium of trade and a store of value depends on its durability. 

Coins and paper notes are designed to operate and serve as money. Nowadays, money is made from paper, metal, and plastic, resulting in a durable medium.

2. Divisibility 

Money's ability to be split into small parts and utilized in exchange for products and services is referred to as divisibility. Due to its divisibility and ability to be exchanged for various items with different values, money may serve as a medium of trade. 

Money needs to have denominations to be used as a means of exchange for all products and services and everything in between.

3. Limited supply 

To be called money, an object must (reasonably) retain its purchasing power through time. 

This money aspect improves efficiency by allowing producers and consumers to time their purchases and sales, instantly minimizing the need to exchange one's income for products and services.

4. Acceptability 

Anything commonly used to pay for goods and services qualifies as money. Money increases efficiency by reducing ambiguity about what will be acknowledged as payment by various companies.

5. Portability

Thanks to portability, consumers may now bring money to use as payment for products and services. 

In the current world, carrying money from one place to another requires little effort since a wallet makes it simple to carry various forms of currency, including coins, bills, and cards.

Types of Money

Money comes in several forms, each with its liabilities and strengths. For example, metal money was formed when metals were abundant; nevertheless, it was eventually superseded by paper money. 

Various commodities were used as a medium of commerce at various times. As a result, the forms of money have evolved in response to resource requirements and availability. The common forms of money are discussed below:

1. Currency 

The unit of exchange for a nation is its currency, issued by its central bank or government, whose value serves as the foundation for commerce. Currency covers both metallic money (coins) and publicly circulated paper money.

• Metallic Currency: Coins used for minor transactions are known as metallic money. The government is the most common issuer of coins. Fifty paise coins and 1, 2, 5, and 10 rupee coins are examples of coinage.
• Paper money: It is used for major transactions and refers to paper notes. The currency denominations and the signatory authority differs from country to country. For example, in India, the governor of the Reserve Bank of India signs the paper notes. 

2. Electronic money 

Computer networks conduct financial transactions electronically, sometimes called digital money, cash, or currency. 

Electronic money is represented through electronic funds transfer (E.F.T.) and direct deposit. A nationwide computer network would track the credits and debits of all individuals, businesses, and governments as economic transactions occurred.

It exchanges money daily without the physical movement of paper money. This lessens the demand for cash and removes the necessity for checks.

3. Commodity money 

When a commodity is traded for commerce, it becomes equivalent to money and is referred to as commodity money. There are certain sorts of commodities that are utilized as commodity money. 

Commodity money is employed in barter systems where valuable resources serve as money. The value of this type of money includes the parties involved in the trade transaction. 

Seashells (also known as cowrie shells) were used as money and a means of trade in various places.

4. Bank money 

It refers to the funds that customers deposit in their bank accounts and on which checks can be issued. In addition, customers deposit coins and currency notes in the bank for safekeeping, money transfers, and to earn interest on their deposits.

This money is credited to the bank's customer's account and can be withdrawn by check at any time. Cheques are generally accepted since they are a convenient way to transfer money.

Functions of Money 

Money is considered as any good universally acknowledged in the exchange of goods and services and the payment of debts. Unfortunately, most individuals will muddle up the concept of money with other concepts such as income, wealth, and credit. 

People would need to trade with one another if there was no such thing as money, which would require that each find other people with whom they have a double coincidence of wants—that is, each side possesses a particular good or service that the other yearns for. 

The primary purpose of money hasn't changed since the time of shells and skins, even though it has undergone significant modification.

Money performs various functions, including a store of value, a standard of deferred payment, an account of value, and a medium of exchange.

Whatever its form, money provides us with a means of exchange for goods and services and facilitates the development of the economy by promoting significantly faster processing.

Let's dive deeper into the functions of money for a better understanding. 

Money as a Medium of Exchange

Since its introduction into the economic system, money has performed its primary function of serving as a medium of trade in society. 

As a means of exchange, money permits human monetary transactions to acquire and possess tangible and intangible commodities and services. For example, as a means of making money, manufacturers sell their products to wholesalers or retailers. 

While wholesalers and retailers offer the same finished items to consumers for money as their profit, similarly, all service providers in society earn money by selling their services in return for money.

For example, if the confectioner who provided the greengrocer with bread had to accept payment in onions and tomatoes, he may dislike these foodstuffs or have an abundance of them.

Because of this, the baker would have to resell the goods, which would take time and be quite uncomfortable. Therefore, it is possible to avoid a lot of hassle by replacing these intricate sales with the usage of money. 

If the confectioner takes money as payment, the money might be spent any way the baker sees fit. Using money as a means of transaction eliminates the disadvantages of barter.

Money as a Store of Wealth

Money's worth must remain constant throughout time; it must serve as a store of value. Previously, products could not store their surplus value in a barter market. However, following the invention of money, the following issue was quickly resolved. 

Sellers and retailers now have a place to save their extra sales revenue. Saving money is now safe in value, so you don't have to worry about it losing weight. Instead of spending it today, you may save it for later use. 

Using commodities as money has several drawbacks, including that over time they degrade and lose economic value. Such commodities include wheat, salt, and even animals like horses or cows. As a result, they are unsatisfactory as a way of storing money. 

Consider a farmer to understand the difficulties of saving in a barter system. He planned to preserve some wheat each week for future use. This, unfortunately, would be useless to him in his old age because the "savings" would have been spent.

Money as a Standard of Deferred Payment

This function is an extension of the first. In this case, money is once more employed as a transaction, but the payment is stretched across time. To be used as payment for other products either upfront or over time, money must be able to function as a monetary transaction.

This implies that products and services, such as hire purchases, can be paid for in installments over time. Transactions, unlike barter exchange, do not have to be settled in one big payment. 

In addition to serving as monetary support for present transactions, money also serves as monetary support for postponed payments, which are future payments. Loan repayments are an example of deferred payments. 

In a modern economy, credit is used in most transactions (both buying and selling). As a result, consumer durables like televisions, for instance, are available for purchase. 

Hire-purchase sets or washing machines are available; residences may be acquired with a L.I.C. or H.D.F.C. loan; most commercial transactions allow for payment in the future for items provided now, and employees must wait a month or a week to collect their paychecks. 

Thus, the use of money allows members of society to postpone their spending from the present to a later period.

Money as a Measure of Value

Money is a unit of account used to measure the value of things consistently. Money is used in this way since it is also a medium of trade. Therefore, money has the property of being used as a unit of account. 

Money is the yardstick by which everything is measured. Everything may be priced or valued in terms of money because money serves as the common denominator. As a result, customers may compare prices and see the relative worth of various items and services.

Measuring and determining the number or volume of commodities sold for another given amount of goods is particularly difficult and demanding in barter trading. 

Knowing the average worth of an item helps the seller and buyer make judgments regarding the number and volume of commodities to be traded.

The conclusion is that financial transactions and the worth of the products and services produced in a nation over time are measured and recorded in terms of money.

Money Creation

According to the nation or the area, the three goals—price stability or inflation targeting, facilitating the achievement of maximum employment in the economy, and ensuring moderate, long-term interest rates—are often included in the mandate of a central bank. 

The central bank is the government's banker, providing various operational services to the government, such as handling the Treasury's single account and serving as its fiscal agent (e.g., by holding auctions), settlement agent, and bond registrar. 

A central bank cannot go bankrupt in its currency. However, a central bank might become bankrupt due to foreign currency commitments. With a few exceptions, central banks exist in almost every country. 

Certain groups of nations where, by agreement, a single institution functions as its central bank, such as the organization of Central African states, which all share a common central bank, the Bank of Central African States.  

Central banking institutions are normally independent of the executive branch of government. However, through the regulation of the base rate, the central bank's actions directly impact interest rates. 

Central banks also indirectly impact stock prices, economic wealth, and the rate at which the local currency is exchanged. 

Monetarists and some Austrians think the central bank should use its monetary operations to manage the money supply. However, the conventional view's detractors argue that central bank actions can influence but not control the money supply.

Researched and authored by Kavya Sharma | Linkedin

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