Nature & Functions of Money

Nature Of Money

Money is only a means and not an end in itself. It is demanded not for its own sake but because it helps us in buying goods and services to satisfy our wants. Money cannot directly satisfy human wants, but assists in production and exchange of goods and services. Its significance lies in its ability to command goods and services and liquidate business obligations. Money gives mobility to capital and aids division of labour and specialisation, thereby making large scale production possible. It has been rightly remarked that 'we cannot eat money but we cannot eat without money either.


Functions Of Money

Money is what money does. According to this statement, the importance of money lies in the functions it performs. Primarily money performs four basic functions which are summed up in the following couplet: "Money is a matter of functions four: A, medium, a measure, a standard & a store." However, it has become customary to classify the functions of money under three heads:

1) Primary Functions - Money performs two basic functions. It acts as a:

i) Medium of exchange

ii) Measure of value.


2) Secondary Functions - The other important functions of money (derived from the primary functions) are:

i) Standard of deferred payments

ii) Store of value

iii) Transfer of value


3) Contingent Functions - In the modern economy money has certain incidental uses like:

i) It is the basis of a credit system

ii) It helps in the distribution of national income

iii) It helps in maximisation of utility as well as of profits

iv) It imparts liquidity to wealth

Let us describe each of these functions briefly.


Primary Functions

1) Money a s a medium of exchange: It is the most important and unique function of money which separates it from near-money assets. The use of money as a common medium of exchange has greatly facilitated the activity of buying and selling goods and services. Without money, exchange could be possible only through barter system whose basic weaknesses have been discussed earlier in this unit on the other hand, the use of money as a medium of exchange avoids most of the problems of a barter exchange.

Though use of money splits exchange into two parts, viz., sale and purchase, but it does not result in loss of time and energy.

2) Money a s a measure of value: Money serves as a yardstick to measure values of all other goods and services in terms of their money price. In the absence of money, value of one commodity could be expressed only in terms of the other goods and services. A s shown earlier, if there are, say, one hundred goods in the market, then under the barter system value of each product will have to be expressed in terms of the remaining 99 goods, i.e., in all there would be 4950 values. On the other hand, if money is used as a measure of value, then we need to measure value of each good in terms of money only, i.e., just 100 values for 100 goods. Further, there are goods which are expressed in different physical units, e.g., a metre of cloth, a kilogramme of wheat, a litre of milk, etc.

Comparison of values of such goods is also possible if we know the money value of these goods. For example, one metre or cloth is equal to 6 kg. of' wheat or 3 litres of milk because they cost the same amount of money etc. The use of money prices also helps us in estimating national income by adding up values of a wide variety of goods and services which are measured in different physical units and hence, cannot be lumped together LO estimate national Income. Also, the use of money makes it possible to compare value of goods over time and between different regions.

However, money as a measure of value can serve satisfactory only when its own value (i.e., purchasing power) remains stable over time. Continuous rise in general level of prices all over the world has made money a poor measure of value.


Secondary Functions

1) Money as a standard of deferred payments: Money facilitates not only the current transactions of g o d s and services but also their credit transactions. It facilitates credit transactions when present goods are exchanged against future payments. In the modem world, the bulk of deferred payments are stipulated in money terms only. Examples in this regard are repayment of loan along with interest, pensions, rents, salaries, insurance premium, etc. Money could be an effective standard of deferred p a p a n t s only if value of money itself does not change. If prices increase or decrease sharply, resulting in large fluctuations in the value of money, it would make money a poor standard of deferred payments.


2) Money as a store of value: People can hold a part of their present earnings in the form of money to be spent in future. Money represents generalised purchasing power and is a perfectly liquid asset as well. Besides, it is durable and more stable in its value. 1 is easy to store as it is relatively light in weight and occupies less space. Hence, it is convenient to accumulate wealth in the form of money which can be converted into any asset at any time. In this way money serves as a bridge from the present to the future, as money saved today implies shifting of purchasing power from the present to the future.


3) Money as a means of transferring purchasing power: Money is the most convenient form in which value can be transferred from one person to another and also from one place to another. It is because money is readily accepted by all and it’s cost of transfer from one place to another is very low due to its high value and less weight compared to other goods. For example, a person can transfer crores of rupees to another person at a distant place with the help of a bank draft or a cheque almost at a nominal cost. But transferring this value in terms of, say, Rice is obviously very difficult, costly and involves wastages.


Contingent Functions

1) Distribution of national income: Money helps in the distribution of national output among the people who have contributed in its production. In a modern society people co-operate together as workers, owners of capital, landlords, etc., to produce goods. The resultant output is, therefore, to be distributed among all of them in the form of wages and salaries, interest, rent, etc. In the absence of money, it would not always be possible to distribute such an output, particularly in case of indivisible goods, e.g., a machine. With the help of money, we can overcome such a problem.


2) Basis of credit system: The modern economy is based on credit i.e., promise to pay. The present-day money itself (coins, currency notes, cheques, bank drafts, etc,) is nothing but only promise to pay. However, this money also helps banks to create more money by the process of credit creation, when the banks expand secondary deposits with the help of cash deposits. In this way money serves as a basis of credit creation by banks.


3) Maximisation of utility and profits: Money helps consumers in maximising their satisfaction. When money is allocated between different goods and services, the consumer maximises his utility. Likewise, producers can calculate money cost of production and then decide the price that can result in maximum profits,


4) Money imparts liquidity and uniformity to assets: It is convenient to hold wealth in the farm of money as it’s the most liquid of all assets. Money can buy any asset and all asset can be converted into money as well. Thus, money imparts liquidity to all assets. Besides, total wealth of a person or a country can be assessed by adding up money values of all assets. Thus, money also brings an element of uniformity to the wealth of the nation.

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