Money

Problems in Barter System

1. Fixing a rate of exchange-the value of each and every good must be expressed in terms of another good which is difficult as some goods were worth more than the others.

2. Double coincidence of want-finding someone who wanted what you had and was willing to give you what you needed. (trade was not possible)

3. Trying to save-some of the items could not be stored for a long period of time and this was an inefficient medium of exchange(perishable goods)

To overcome these issues, people started to use a single commodity called money. This commodity was such that everyone was willing to accept in exchange for their labour and goods or services.

What is money?

It is an acceptable medium of exchange. It is used to support specialisation and exchange. Notes and coins and deposits with banks and other financial institutions make up the money supply in an entire economy.

Functions of money:

"Money is a matter function four a medium, a measure, standard and store"

(Medium and measure are the primary functions)

(Standard and store are the secondary function)

1. Medium of exchange: money acts as a medium of exchange between two people; producers and consumers of goods and services. Easy transactions and overcomes the difficulty of double coincidence of want.

2. Measurement of value: money acts as a measurement of value (unit of account). It can help identify the value of a product. Value expressed in terms of money. Overcomes the lack of unit value and impossibility of division.

3. Standard deferred payment: one can delay the payment, eg: borrowing money as a loan and planning to repay a few months later (not possible in the barter system as one cannot identify interest in barter).

4. Money acts as a store value: avoids the difficulty of lack of storage facility as it is portable. The value of money can be increased over time.

Evolution of money

Stage 1: Commodity money: products available nearby like shells and stones (lack unit value), animals (not divisible).

Stage 2: Precious stones: gold and silver, used during monarchy for trade. Value depreciates over time and could not be used as ornaments. Chances of running out of materials. Only rulers had access and villagers depended on the mercy of the king to receive some stones. Safety issues and people started finding alternatives such as nickel and aluminium coins. They were very heavy to transport and very rare to find.

Stage 3: Paper notes (currency): advantages- convenient, light weight, easy to carry and transport, accepted by all. They had face value and intrinsic value (core value). Face value means they had an amount written on them. The core value of the product is the value of the material. In the event any paper note is declared null and void the RBI promises to pay the bearer the equal amount of the money abandoned.

Qualities of good money:

• Acceptability (accepted by everyone)

• Durability (long lasting)

• Portability (convenient and easy to carry)

• Scarcity (to avoid inflation and recommend savings)

• Uniformity (all notes are same and issued by the government)

• Divisibility (divisible as they have a face value)

Forms of money:

• Money in forms of assets is called near money. They are financial assets and cannot be quickly exchanged for money (no immediate transaction). Eg - properties, shares, stocks, mutual funds, fixed deposits etc.

• Liquid money is the form of money that one has immediate access to or can consume immediately. Can easily be converted to money. Eg - bank deposits, jewellery, gold etc.

• Coins (metal coins)

• Paper notes (current currency)

• Jewellery and valuable antiques are physical assets and they provide a good store of value

Why is money important?

Money as we know, supports trade and exchange between individuals and/or firms. Money encourages specialisation which helps make trade easier. This also enables an economy to increase its national output and income and allows people to enjoy a higher standard of living. Money is needed by consumers, firms and governments to make payments to hire labour and buy other resources and goods and services.

Who provides this money?

The banking system can provide money and make it easier to make payments. Therefore, as the output of an economy grows and to make more trades, the banking system must develop or create more money.

Some assets fulfil the functions of money better than others. Some assets can be converted to cash more quickly than others. Some assets retain their value on conversion to cash better than others.