Revision Notes: Meaning and Functions of Money | Economics Class 10 ICSE PDF Download

Meaning of Money

Money refers to anything that is widely accepted as a medium of exchange. It serves various purposes, including being a medium of exchange, a measure of value, a store of value, and a standard for deferred payments.

Difficulties of the Barter System

The barter system is an ancient method of exchanging goods directly for other goods. In this system, the sale and purchase of goods happened simultaneously, and their values were equal at that moment. However, with the advent of money, people could buy or sell goods with cash without the need to exchange goods at the same time. This separation of purchase and sale was made possible by money.

• Lack of Double Coincidence of Wants: In the barter system, if a person wants to exchange a particular good, they need to find someone who has the desired good and is also willing to accept the good they offer. This double coincidence of wants makes exchanges difficult.

• Lack of Store of Value: Without money, wealth was stored in the form of goods. However, storing goods comes with costs, potential loss of value, and challenges in transfer. This makes it impractical to store people’s purchasing power in goods.

• Lack of Divisibility: Not all goods can be divided or subdivided easily. In the absence of a common medium of exchange, problems arise when trying to exchange a large, indivisible commodity for a smaller one.

• Lack of Deferred Payment: Money has facilitated deferred payments. When money is borrowed, the principal and interest amounts need to be repaid to the lender. Such transactions are not feasible with goods and services.

• Problem of Storing Wealth: Without money, individuals had to store their wealth in the form of goods. However, the value of stored commodities can change over time, and storing certain goods for extended periods can be more expensive.

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Evolution of Money

The concept of money has evolved over time through various stages, influenced by different factors such as time, place, and circumstances.

1. Commodity Money:

• The earliest form of money involved various commodities, known as commodity money.
• This was the most primitive form of money.
• However, it faced challenges like improper standardization, indivisibility, and storage difficulties, making it an unsuitable medium of exchange.

2. Metallic Money:

• Metallic money included mono-metalism (using one type of metal) and bi-metalism (using two types of metals) with valuable metals like gold and silver.
• Different sections of society agreed to consider certain precious metals as a common medium of exchange.
• For example, King Kanishka of the Kushan Dynasty introduced the gold coin in India during the first century AD.

3. Paper Money:

• The paper currency system involves the use of coins and currency notes as a medium of exchange.
• As trade and commerce expanded, the demand for money increased, leading to the replacement of metallic money by paper money.
• The Central Bank of a country has the authority to issue paper money of specific denominations and values.
• Fiat money refers to a medium of exchange that is generally acceptable and enforced by law, such as rupee notes and coins.

4. Bank Money:

• The final stage in the evolution of money is bank money, which involves demand deposits with commercial banks.
• Demand deposits, such as current account deposits, are payable on demand by cheques.
• Cheques drawn on the demand deposits of commercial banks can be used as a medium of exchange.

Narrow and Broad Definitions of Money

Narrow Definition of Money

M1: This includes:

• Currency with the public: Physical money in circulation among the public.
• Demand deposits with commercial banks: Money held in accounts that can be accessed on demand, such as current accounts.
• Deposits kept by commercial banks with the Reserve Bank: Funds that commercial banks hold with the Reserve Bank.

Broad Definition of Money

M2: This includes M1 plus savings deposits with post office savings banks.

M3: This includes M2 plus term deposits in commercial banks.

M4: This includes M3 plus savings with the post office other than in the form of National Saving Certificates.

Demand Deposits: These are current account deposits with banks or other financial institutions that are payable on demand by cheques. Banks do not provide interest on these deposits.

Time Deposits: These are fixed-term deposits with a specified maturity period, ranging from 7 days to 10 years. Time deposits cannot be accessed on demand and do not come with cheque-writing privileges, but they do earn interest on the deposited amount.

Features of Money

• General Acceptability: Money should be universally accepted in exchange for goods and services.
• Divisibility: It should be easily divisible into smaller units to facilitate transactions.
• Durability: Currency notes and coins should be durable, allowing for repeated use over many years.
• Cognisability: Money must be easily recognizable, with distinct features to prevent confusion.
• Portability: It should be easy to transport money from one place to another.
• Homogeneity: Different units of money should be uniform in quality.
• Stability: Money should have a stable value to serve as a reliable measure of worth.

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Kinds of Money

• Standard Money: Also known as fiat money, this includes currency notes and coins issued by the government.
• Bank Money: Refers to bank deposits that can be withdrawn using cheques and drafts.
• Near Money: These are highly liquid assets that can be quickly converted into cash, such as bank deposits and treasury bills.

Functions of Money

Primary Functions:

Medium of Exchange: Money facilitates exchange by overcoming the limitations of the barter system.

Measure of Value: Money provides a standard measure of the market value of goods and services.

Secondary Functions:

Standard of Deferred Payments: Money simplifies future payments, making it easier to repay loans with principal and interest, unlike goods and services.

Store of Value: People hold wealth in money because it is the most liquid form of wealth. Saving in money allows for future purchases, effectively storing the value of commodities.

Transfer of Value: Money enables the transfer of value from one person to another during transactions, such as when a buyer pays a seller.

Contingent Functions:

Assisting Production Decisions: Money prices of production factors guide producers in deciding how much of each factor to use for profit.

Assisting Consumption Decisions: A consumer's income level and the money prices of available goods influence their consumption choices.

Assisting Distribution of National Income: Money prices determine the wages, interest, rent, and profits received by factor owners, which constitute the national income and its distribution.

Assisting Operation of Credit System: Money underpins credit operations conducted by businesses and financial institutions.

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Significance of Money in Economic Development

As an economy develops, there is a significant increase in economic transactions. Money, being widely acceptable, is crucial as a medium of exchange. It is considered a dynamic factor for several reasons:

• Unlimited Exchange: Money facilitates exchange without limits.
• Wealth Accumulation: It allows for the accumulation of wealth for investment purposes.
• Capital Flow: Money enables the movement of capital from one place to another, both within and outside countries.
• Economic Stability: It contributes to economic stability and promotes national growth.