11.

Money- Meaning, Functions, Classification and

Greshams Law
Obecti!es"
After studying this lesson, you will be able to understand,
The meaning of money.
The different functions of money
The classification of money.
Meaning of Grashams law
11.1 Definition of money
11.2 Functions of Money
11.2.1 Main Functions
11.2.2 econdary Functions
11.2.! "ontingent Functions
11.2.# $ther functions of money
11.! "lassification of money%
11.!.1 &egal Tender Money'
11.!.2 $(tional money%
11.!.! Metallic Money%
11.!.!.1 tandard Money%
11.!.!.2 To)en money%
11.!.!.! ubsidiary money%
11.# *a(er Money%
11.#.1 +e(resentati,e *a(er Money%
11.#.2 "on,ertible *a(er Money%
11.#.! -ncon,ertible (a(er money'
11.#.# Fiat Money%
11.. Greshams &aw"
11./ ummary
11.0 "hec) your (rogress
11.1 2ey conce(ts
11.3 elf Assessment 4uestions
11.15 Answers to chec) your (rogress
11.11 uggested +eadings
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11.1 #efinitions of money"
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Money has been defined differently by different economists, as there is no unanimity
o,er its definition. ome definitions are too e7tensi,e while others are too narrow. For
e7am(le, 8al)ers definition is too wide. -n 8al)ers words9 Money is what money
does9. According to this definition, we can include all those things in money, which
(erform the functions of money. Thus money does not com(rise metallic coins and
currency notes only. -t also includes che4ues, hundies, bills of e7change, etc., because
they also (erform the functions of money. $n the other hand, +obertsons definition of
money is rather narrow.
According to him, Money is a :commodity, which is used to denote anything which is
widely acce(ted in a (ayment for goods or in discharge of other business obligations9.
According to this definition, metallic money alone deser,es to be called money in the
strict sense of the term because it alone is generally acce(table by the (eo(le, left to
them. This definition unnecessarily narrows down the field of money.
ome economists define money in legal terms saying that ;anything which the state
declares as money is money9. Thus, money (ossesses legal sanction to discharge debts
and (erform other functions of money. <ut legal sanction alone is not a significant factor
in ma)ing money generally acce(table. The ban) de(osits or credit money are not legal
tender money but these are generally acce(table in (ayment and actually constitute a
ma=or (art of the circulating medium.
>one of abo,e definitions is satisfactory since they are either two wide or too narrow. A
suitable definition of money should em(hasi?e not only the im(ortant functions of
money, but also its basic characteristic, namely, general acce(tability. From this (oint of
,iew, "rowther' s definition a((ears to be ideal definition. @e defines money as
;anything that is generally acce(table as a means of e7change and that at the same time
acts as a measure and as a store of ,alue9. This definition (oints out that money should
(erform all the three im(ortant functions of being a medium of e7change, a standard of
,alue, and a store of ,alue. <esides, money should be a commodity, which is generally
acce(table by the community in (ayment for anything. -n other words, the commodity
chosen as money must be uni,ersally acce(table within community in e7change for
goods and ser,ices or in (ayment of debts.
11.$ Functions of Money"
The most general way to define money is to lay down its main functions. The ,arious
functions of money can be classified into four grou(s.
1A Main Functions
2A econdary Functions
!A "ontingent Functions
#A $ther Functions.
&et us now try to understand initially about the main functions of money.
11.$.1 Main Functions"
These are also referred to as original functions of money. Following are the two main
functions of money%
aA Money is a Medium of e7change%
bA Money is a measure of ,alue
Money is a Medium of %&change"
This may be considered as the most basic function of money. Money has the 4uality of
general acce(tability. As such, all e7changes ta)e (lace in terms of money. -n ancient
times, commodities used to be e7changed for commodities. That was )nown as <arter
system. <ut, with the la(se of time, the barter system (ro,ed difficult and incon,enient
for the (eo(le. The main difficulty of the barter system was the lac) of double
coincidence of wants. -t was on account of the difficulties and incon,eniencies of barter
that money came into e7istence. -n the modern money e7change system, the (rices of
goods and ser,ices are e7(ressed in terms of money. $n account of the use of money, the
e7change transactions ha,e now come to be di,ided into two (arts. $ne is (urchases and
another one sale. Thus, in the modern society money acts as intermediary are sales and
(urchases. -t is on this account that money is referred to as the medium of e7change. The
difficulty of the lac) double coincidence of wants no longer e7ists now on account of the
in,ention of money. ince money is generally acce(table, e,eryone acce(ts it in
e7change for goods and ser,ices and utili?es it for (urchasing goods and ser,ices of his
choice. Money thus, (romotes s(eciali?ation among indi,iduals, firms and regions.
ince money is a medium of e7change, it bestows u(on the holder the (ower to command
mar)etable goods and ser,ices at his own o(tion whene,er he needs them. -f the
indi,idual concerned has no money, he may ha,e to borrow it to ac4uire the necessary
command o,er mar)etable goods and ser,ices for his own benefit.
Money is a Measure of 'alue"
The second im(ortant function of money is that it measures the ,alue of goods and
ser,ices. -n other words, the (rices of all goods and ser,ices are e7(ressed in terms of
money. ince all ,alues are e7(ressed in terms of money, it is easier to determine the rate
of e7change between ,arious ty(es of goods and ser,ices in the community. <ut the
(eo(le en=oyed no such facility under the barter system. -n ,iew of its function as a
measure of ,alue, money also ser,es as a unit of account. -t means that all records are
)e(t and maintained in terms of the monetary unit, for instance in -ndia +u(ee.
-t may howe,er, be (ointed out that money still (resents a difficulty in its role as a
collecti,e measure of ,alues. The difficulty is that the ,alue of money itself is sub=ect to
changes from time to time.
11.$.$ (econdary Functions"
Money as a standard of #eferred )ayments*
-n the absence of money, borrowing and lending were difficult or borrowed and lending
amount could be returned only in terms of goods and ser,ices, but the modern money
economy has greatly facilitated the borrowing and lending (rocess in terms of money. -n
other words, money now acts as the standard of deferred (ayments for the following
reasons% the ,alue of money is stable com(ared to the ,alues of other commodities,
Money is more durable com(ared to other commodities% Money has the 4uality of general
acce(tability. @ence it continues to be always desirable. <ut in its role as a standard of
deferred (ayments, money also suffers from certain drawbac)s. They are' its own ,alue is
not wholly stable. $n the contrary, its ,alue )ee(s on fluctuating from time to time. As a
conse4uence, debtors and creditors are differently affected at different times. For
instance, if the ,alue of money de(reciates on account of a (rice rise, the creditors lose
while debtors gain.
Money is a (tore of )urchasing )ower"
Money should ha,e store of ,alue character. $therwise it is of no use in sa,ing under
barter system. <ecause sa,ings in terms of goods and ser,ices are not (ermanent and
some of which ha((ened to be (erishable. Thus sa,ings done in terms of money under
modern money economy are more (ermanent and money made (ossible ca(ital
accumulation, which is an essential, (rere4uisite of economic growth. Money also ser,es
as an e7cellent store of wealth, as it can be easily con,erted into other mar)etable assets,
such as, land machinery, (lant etc., but money can (erform this function satisfactorily
only if its own ,alue is fairly stable.
As a store of ,alue, (eo(les (reference of money o,er other assets flows essentially from
the characteristic li4uidity of money and the uncertainty about the future ,alue of non6
money assets. <y acting as a store of ,alue, money (ro,ides a lin) between the (resent
and the future.
As mentioned earlier, though there are contingent and other functions of money, but as a
student of BG, it is sufficient to learn abo,e stated im(ortant functions of money.
@owe,er, list out the contingent and other functions in brief in the following.
11.$.+ Contingent functions% money will act as the basis of credit to be created by
commercial ban)s, money also facilitates the distribution of social income among the
(o(ulation in an economy, money hel(s to e4uali?e marginal utilities and marginal
(roducti,ities and money increases (roducti,ity of ca(ital.
11.$., Other functions of money% Money hel(s to maintain re(ayment ca(acity, money
re(resents generali?ed (urchasing (ower and money gi,es li4uidity to ca(ital.
11.+ Classification of money"
Different economists on the basis of different criteria ha,e classified money. $n the basis
of legality, money can be classified under two heads%
11.+.1 Legal -ender Money*
-t is that money which is acce(ted as a means of (ayment both by the Go,t as well as the
(eo(le. This ty(e of money has legal sanction behind it. >o one refuse to acce(t it as a
means of (ayment.
&egal tender money can be further subdi,ided under two heads% aA limited legal tender, bA
unlimited legal tender.
Limited Legal -ender is that money which no (erson can be forced to acce(t beyond a
certain ma7imum limit. The Go,t under statute fi7es the ma7imum limit. For e7am(le
1,2,.,15,25 and 2. (aise coins are legal tender only u( to a sum of ru(ees twenty6fi,e. -f
some one is called u(on to acce(t the small coins beyond the ma7imum limit of +s 2.C6 is
(erfectly free to refuse them. <ut u( to the limit of +s. 2.C6, he cannot refuse the small
coins under the (ro,isions of the law.
.n-Limited Legal -ender is that money which a (erson has to acce(t u( to any limit,
because it is an unlimited legal tender. This ty(e of money acce(ted by the (eo(le to an
unlimited e7tent. For e7am(le, one ru(ee coins, fifty (aise coins and (a(er notes of all
denominations are unlimited legal tender in -ndia.
11.+.$ O/tional money"
-t is that money, which ordinarily acce(ted by the (eo(le, but has no legal sanction
behind it. >o one can be forced to acce(t this ty(e of money against his wishes. -t is
o(tioned money. -f the (ersons is (aying this money en=oys high credit in the mar)et,
e,eryone will readily acce(t it. <ut as (ointed out abo,e, no one can be forced to acce(t
it. Different ty(es of credit instruments li)e che4ues, hundies and bills of e7change are
e7am(les of o(tional money.
Money can be classified under two sub6heads on the basis of the commodity used in
ma)ing it.
1A Metallic money
2A *a(er money
11.+.+ Metallic Money"
This money is made of a (articular metal Di.e., Gold, il,er, "o((er, >ic)el, etc.,A.
Metallic Money is further classified under three sub heads%
aA tandard Money
bA To)en Money
cA ubsidiary Money
11.+.+.1 (tandard Money"
This is also referred to as the (rinci(le money or full6bodied money. tandard coins are
made of gold or sil,er. These coins are made of a well6defined weight and fineness.
tandard money has the following characteristics%
1A tandard coin is the (rinci(al coin of the country. As such, it is the medium of
e7change and also the money of account. 8hen the standard coin is made of one
metal, the monetary system is )nown as mono6mettalism. -f this metal is gold, the
system is referred to as gold mono6metallism. -n case, the standard coin is made
of sil,er only, the system is )nown as sil,er mono6metalism.
ome times, the standard coins are made of gold as well as of sil,er. -n other
words, two ty(es of standard coins are in circulation6 one made of gold and the
other of sil,er. uch a monetary system is )nown as <i6metalism.
2A The Face ,alue of standard money is e4ual to its intrinsic ,alue. The face ,alue of
standard money is always e4ual to its metallic or intrinsic ,alue. -n other words,
the standard coin com(rises metal whose ,alue is e4ual to its face ,alue. -f some
one melts down a standard coin and sells the bullion in the mar)et, he suffers no
loss because the coin contains metal e4ui,alent to its face ,alue. That is why the
standard money is )nown as full6bodied money. For e7am(le, the -ndian ru(ee
before 113! was a standard coin. -t had in it sil,er whose metallic ,alue was e4ual
to its face ,alue.
!A There is free coinage of standard money. A s(ecial characteristic of standard
money is that it is minted under free coinage. Bnder free coinage as is well
)nown, the mint is o(en to the (ublic. Bnder the system, the (eo(le ha,e the right
to ta)e their gold or sil,er to the mint for getting it con,erted into coins. For this
ser,ice rendered to the citi?ens, the mint some times charges fee, but some times
it does not. The main ad,antage of this system is that there is no shortage of coins
in the country. 8hene,er the (eo(le e7(erienced shortage of coins they can ta)e
their gold or sil,er to the mint and get it con,erted into coins.
#A tandard money is unlimited legal tender money. An im(ortant characteristic of
standard money is that its unlimited legal tender, because its the (rinci(al
monetary unit of the country. All big (ayments can be made in terms of standard
money to an unlimited e7tent.
11.+.+.$ -o0en money"
The to)en money is used for ma)ing smaller (ayments. -t ser,es as a subsidiary for
standard money. -t is generally made of inferior and light metals, such as, co((er,
nic)el etc, To)en money is different from standard money in se,eral res(ects, - shall
then briefly in the following sentences%
1A There is no free coinage of to)en money. The go,ernment only mines this, the
(ublic en=oys no right to ta)e the metals to the mint and get them con,erted into to)en
coins.
2A The face ,alue of to)en money is higher than its intrinsic ,alue.
!A To)en money is limited legal tender money% To)en coins can be used for ma)ing
(ayments only to a limited e7tent. >o one can be forced to acce(t then coins
beyond a certain limit.
#A To)en money is a subsidiary of standard money% To)en coins are generally used
for ma)ing (ayments in smaller transactions. As such, they act as subsidiaries of
standard coins.
&et us see the merits and demerits of standard coins in brief%
Merits of (tandard Coins"
aA -ns(ire grater confidence
bA Means of storing (urchasing (ower
cA Easy acce(tability in foreign countries
dA >o fear of inflation
#emerits of (tandard Coins"
aA >ot economical
bA tandard money is not elastic
>ow let us also study the merits and demerits of To)en coins%
Merits of -o0en Coins"
aA Economical use of metals
bA To)en currency is much more elastic
#emerits of -o0en Coins"
aA -ns(ire less confidence
bA "onsistability
cA Fear or o,er6issue
dA Acce(tability within the country
eA &imited legal tender
11.+.+.+ (ubsidiary money"
ubsidiary coins are issued to facilitate smaller (ayments. The main characteristics of
subsidiary coins are%
aA The subsidiary coins are low6,alue coins and are made of lighter metals.
bA They facilitate the e7change of low6(riced goods and ser,ices
cA There coins are not sub=ect to free coinage, they are issued by the go,ernment
itself
dA All subsidiary coins are to)en coins
eA The relationshi( of subsidiary coins with the standard coins is defined and
determined under statute.
11., )a/er Money"
*a(er money has a long history to its credit. "hina was the first in the world to ma)e use
of this in the 3
th
century and it began in -ndia in the 13
th
century.
*a(er money can be classified under three heads%
1A +e(resentati,e *a(er Money
2A "on,ertible *a(er Money
!A -n6"on,ertible *a(er Money
11.,.1 1e/resentati!e )a/er Money"
This ty(e of (a(er money is fully bac)ed u( by Gold and il,er reser,es. -n the
beginning to a,oid wastage of metals the (a(er currency was issued. @ence, the monetary
authority maintained metallic reser,es e4ui,alent to the ,alue of (a(er notes issued. The
demand for con,erting (a(er notes into cash was met by ma)ing use of gold and sil,er
)e(t in reser,es. Thus, under the system of re(resentati,e (a(er money, gold and sil,er
e4ui,alent to the ,alue of (a(er notes issued were )e(t in reser,es by the monetary
authority.
Main ad,antages and disad,antages of +e(resentati,e money are as follows%
2d!antages of 1e/resentati!e money "
aA >o fear of inflation
bA Economy in use of ,aluable metals
cA *ublic confidence
#isad!antages of 1e/resentati!e money"
aA >o sa,ing in gold and sil,er
bA &ac) of elasticity
cA Bnsuitable for (oorer countries
11.,.$ Con!ertible )a/er Money"
-t refers to that ty(e of (a(er money, which is con,ertible into standard coins at the
o(tion of the holder. The characteristics of con,ertible (a(er money gi,e us a better
understanding of this.
aA The basic (rinci(le underlying this system is that the (ublic for encashment does
not simultaneously (resent all the notes. Therefore, the ,alue of gold, sil,er )e(t
in reser,es is less that the ,alue of notes issued by monetary authority.
bA The monetary authority assures the (ublic that they can get their (a(er notes
con,erted into cash at their o(tion.
cA The a((ro,ed securities such as gold, and sil,er can be encashed at anytime.
dA Thus, gold and sil,er in the reser,es are not )e(t e4ui,alent to the ,alue of the
(a(er currency issued, but they are some what less than that of currency under
this system the reser,es com(rise two (ortions%
iA Metallic (ortion6 this (ortion contains gold, sil,er and standard coins and,
iiA Fiduciary (otion F this (ortion contains only a((ro,ed securities
eA Bnder this system, the (eo(le are gi,en gold and sil,er in e7change for (a(er
currency for ma)ing (ayments abroad.
fA The go,ernment is e,er ready to buy gold and sil,er at (redetermined rates.
Merits and demerits of the ty(e of money are as follows'
Merits of con!ertible /a/er money"
aA Economy in use of ,aluable metals
bA Fle7ibility
cA -ns(ire greater (ublic confidence
dA Facility in foreign trade
#emerits of con!ertible /a/er money"
aA Fear of o,er Fissue of (a(er currency
bA -t does not ins(ire as much confidence as re(resentati,e money
Though this system s(read to many countries and is widely ado(ted, its the system of
incon,ertible money, which is in force.
11.,.+ 3ncon!ertible /a/er money*
This system (re,ails in a country when the monetary authority gi,es no guarantee to
con,ert the (a(er notes into coin or other ,aluable metals. uch a ty(e of (a(er currency
circulation account of the high credit en=oyed by the monetary authority. The following
are its characteristics.
aA Bnder this system. The issuing authority )ee(s no metallic reser,es behind (a(er
currency nor does it guarantee the con,ertibility of (a(er note into coins and
metals. -ts (ossible that the issuing authority bac)s u( the note6issue with
go,ernment securities, treasury bills and e,en bonds.
bA uch ty(e of (a(er currency can be issued at best only in limited 4uantity but if
need arises, the issuing authority may issue more (a(er notes without metallic
co,er.
11.,., Fiat Money"
&astly, this is only a ,ariety of in con,ertible fiat money and is issued generally at a time
of crisis. That is why its sometimes referred to as emergency currency. >o reser,es of
any ty(e are )e(t behind and are neither bac)ed u( by the metallic and fiduciary co,er.
The monetary authority gi,es no guarantee to con,ert fiat money into metallic coins. The
main characteristics of fiat money may be summed u( as follows%
aA Fiat money is issued in limited 4uantities
bA Fiat money is issued at a time of crisis
cA There is no6co,er Dmetallic or fiduciaryA behind it
The fact of the matter is that fiat money is an e7tra6ordinary ty(e of money and is issued
under s(ecial circumstances. Fiat money is howe,er, is an unlimited legal tender.
At the outset, the abo,e mentioned are the different ty(es of money which ha,e been and
are being used in the countries to carry on their daily transactions. The di,isions and sub6
di,isions made it easier, though money has undergone many changes from barter system
to the (resent day (a(er currency, howe,er we may call it, it is highly essential.
11.4 Greshams Law"
Gueen Eli?abeth of England wanted to reform the currency system which was e7isted
during the time of her grandfather to ha,e a single unified currency in order to strengthen
the trade and commerce in the country. he was introduced reform of the currency
system by issuing new coins of better weights and sha(e with the ho(e that (ublic will
de(osit the old dishonored coins in treasury and ,ery soon the wor) of currency reforms
would be successfully accom(lished. <ut to her absolute disa((ointment she found that
the new coins disa((eared from the circulation no sooner these were issued from the
mint. B(set by this situation the 4ueen on the ad,ice of her minister consulted (ir
-homas Gresham who was the master of the mint under 4ueen Eli?abeth. Gresham
en4uired about the (henomenon in 1..1 and came to the conclusion that bad money
dri,es out good money. This has to be come to )nown as Greshams law.
8hen two )inds of money in circulation the (roblem before the go,ernment is to )ee(
them concurrently in circulation. 8hen the two currencies ha,ing the legal ,alue ha,e
different intrinsic or real ,alue in the domestic or foreign mar)et then the money ha,ing
higher mar)et ,alue is set to be under ,alued currency while other set to be o,er ,alued
currency. A money o,er ,alued by the go,ernment is that which has less (urchasing
(ower in the mar)et. -n such a situation the o,er ,alued currency will tend to dri,e out
the under ,alued currency from circulation. The under ,alued currency is withdrawn from
monetary use melted and di,erted to non monetary uses. Greshams law is based on this
obser,ation.
A basic as(ect of Greshams law is that the under ,alued money can remain in circulation
at home only if it will circulated at a (remium. This conclusion follows from the fact that
(eo(le will not s(end the under ,alued money at home on the same basis as the o,er
,alued money when they can get relati,ely more for the under ,alued money in foreign
countries.
11.5 (ummary
Money has been defined differently by different economists, as there is no unanimity
o,er its definition. ome definitions are too e7tensi,e while others are too narrow. And as
(ar as concerned with the classification of money, different forms of money and its
ad,antages as well as disad,antages also discussed in this lesson. 8e also co,ered what
is Greshams law and its im(ortance. -t is in this ,iew money has been (laying )ey role in
an economy. @owe,er, money no doubt, is a significant and im(ortant factor in the
o(erations of a modern economy, yet its limitations cannot be o,erloo)ed or ignored in
any fair e,aluation of the role (layed by it.
11.6 Chec0 your /rogress
8hether the following statements are true or false
1. 7 Money is what money does9 said by wal)er
$. Money is in the normal sense, means currency
+. Measure of ,alue is an essential function of money
11.8 9ey conce/ts
Medium of e7change
Measure of ,alue
tore of ,alue
Differed *ayments
+e(resentati,e Money
Fiat money
11.: (elf 2ssessment ;uestions
1 Define money and e7(lain its main functions
2. E7(lain the ,arious ty(es of money and briefly mention their characteristics
,. Distinguish between "on,ertible and incon,ertible (a(er money
4. 8hat is Greshams law
11.1< 2nswers to chec0 your /rogress
1. false 2. False ! True
11.11 (uggested 1eadings
Ac)ley Gardner % Macro economic theory
8ard + A% Monetary theory and (olicy
+ana H Ierma % Macro economic analysis
@a=ela T>% Monetary economics
Ghata) % Monetary economics in de,elo(ing economies
Various functions of money can be classified into three broad groups:
(a) Primary functions, which include the medium of exchange and the measure of
value;
(b) Secondary unctions which include standard of deferred payments, store of value
and transfer of value; and
(c) !ontingent functions which include distribution of national income,
maximi"ation of satisfaction, basis of credit system, etc# $hese functions have been
explained below:
1. Medium of Exchange:
$he most important function of money is to serve as a medium of exchange or as a
means of payment# $o be a successful medium of exchange, money must be
commonly accepted by people in exchange for goods and services# %hile functioning
as a medium of exchange, money benefits the society in a number of ways:
(a) &t overcomes the inconvenience of baiter system (i#e#, the need for double
coincidence of wants) by splitting the act of barter into two acts of exchange, i#e#,
sales and purchases through money#
(b) &t promotes transactional efficiency in exchange by facilitating the multiple
exchange of goods and services with minimum effort and time,
(c) &t promotes allocation efficiency by facilitating speciali"ation in production and
trade,
(d) &t allows freedom of choice in the sense that a person can use his money to buy
the things he wants most, from the people who offer the best bargain and at a time he
considers the most advantageous#
2. Measure of Value:
'oney serves as a common measure of value in terms of which the value of all goods
and services is measured and expressed# (y acting as a common denominator or
numeraire, money has provided a language of economic communication# &t has made
transactions easy and simplified the problem of measuring and comparing the prices
of goods and services in the mar)et# Prices are but values expressed in terms of
money#
'oney also acts as a unit of account# *s a unit of account, it helps in developing an
efficient accounting system because the values of a variety of goods and services
which are physically measured in different units (e#g, +uintals, metres, litres, etc#)
can be added up# $his ma)es possible the comparisons of various )inds, both over
time and across regions# &t provides a basis for )eeping accounts, estimating national
income, cost of a proect, sale proceeds, profit and loss of a firm, etc#
$o be satisfactory measure of value, the monetary units must be invariable# &n other
words, it must maintain a stable value# * fluctuating monetary unit creates a number
of socio,economic problems# -ormally, the value of money, i.e., its purchasing
power, does not remain constant; it rises during periods of falling prices and falls
during periods of rising prices#
3. Standard of Deferred Payments:
%hen money is generally accepted as a medium of exchange and a unit of value, it
naturally becomes the unit in terms of which deferred or future payments are stated#
$hus, money not only helps current transactions though functions as a medium of
exchange, but facilitates credit transaction (i#e#, exchanging present goods on credit)
through its function as a standard of deferred payments# (ut, to become a
satisfactory standard of deferred payments, money must maintain a constant value
through time ; if its value increases through time (i#e#, during the period of falling
price level), it will benefit the creditors at the cost of debtors; if its value falls (i#e#,
during the period of rising price level), it will benefit the debtors at the cost of
creditors#
4. Store of Value:
'oney, being a unit of value and a generally acceptable means of payment, provides
a li+uid store of value because it is so easy to spend and so easy to store# (y acting as
a store of value, money provides security to the individuals to meet unpredictable
emergencies and to pay debts that are fixed in terms of money# &t also provides
assurance that attractive future buying opportunities can be exploited#
'oney as a li+uid store of value facilitates its possessor to purchase any other asset
at any time# &t was .eynes who first fully realised the li+uid store value of money
function and regarded money as a lin) between the present and the future# $his,
however, does not mean that money is the most satisfactory li+uid store of value# $o
become a satisfactory store of value, money must have a stable value#
. !ransfer of Value:
'oney also functions as a means of transferring value# $hrough money, value can be
easily and +uic)ly transferred from one place to another because money is acceptable
everywhere and to all# /or example, it is much easier to transfer one la)h rupees
through ban) draft from person * in *mritsar to person ( in (ombay than remitting
the same value in commodity terms, say wheat#
". Distri#ution of $ational %ncome:
'oney facilitates the division of national income between people# $otal output of the
country is ointly produced by a number of people as wor)ers, land owners,
capitalists, and entrepreneurs, and, in turn, will have to be distributed among them#
'oney helps in the distribution of national product through the system of wage, rent,
interest and profit#
&. Maximi'ation of Satisfaction:
'oney helps consumers and producers to maximi"e their benefits# * consumer
maximi"es his satisfaction by e+uating the prices of each commodity (expressed in
terms of money) with its marginal utility# Similarly, a producer maximi"es his profit
by e+uating the marginal productivity of a factor unit to its price#
(. )asis of *redit System:
!redit plays an important role in the modern economic system and money
constitutes the basis of credit# People deposit their money (saving) in the ban)s and
on the basis of these deposits, the ban)s create credit#
+. ,i-uidity to .ealth:
'oney imparts li+uidity to various forms of wealth# %hen a person holds wealth in
the form of money, he ma)es it li+uid# &n fact, all forms of wealth (e#g#, land,
machinery, stoc)s, stores, etc#) can be converted into money#
0conomists are not in agreement on the +uestion of definition of money supply#
$here are four broad approaches of money supply# $hey are as follows:
1. !raditional /00roach:
$he traditional approach emphasises the medium of exchange function of money#
*ccording to this approach, money supply is defined as currency with public and
demand deposits with commercial ban)s# 1emand deposits are the current accounts
of depositors in a commercial ban)#
$he traditional approach is analytically superior because it provides the most li+uid
and exact measure of money supply#
$he central ban) can have better control over the money supply if it includes
currency and demand deposits of ban)s alone# (ut, this approach limits money
supply to a very narrow area#
2. Monetarist /00roach:
$he !hicago School led by 'ilton /riedman includes in money supply currency plus
demand deposits plus time deposits# $ime deposits are fixed deposits of the ban)s
which earn a fixed rate of interest depending upon the period for which the amount
is deposited#
*ccording to /riedman money is defined as 2anything that serves the function of
providing a temporary abode of purchasing power#2
'oney can act as a temporary abode of purchasing power if it is )ept in the form of
cash, demand deposits or any other asset which is close to currency, i#e#, time
deposits# $his approach lays emphasis on the store of value function of money and
provides a broader measure of money#
3. 1urley and Sha2 /00roach:
3urley and Shaw further widened the scope of money supply by including in its
constituents currency plus demand and time deposits of ban)s plus the liabilities of
non,ban)ing intermediaries# $he liabilities of non,ban)ing intermediaries cover
saving ban) deposits, shares, bonds, etc# and are close substitutes to money#
4. 3adcliffe *ommittee /00roach:
4adcliffe !ommittee approach or li+uidity approach provides much wider view of the
concept of money supply# &n this approach, the concept of money supply is viewed in
terms of general li+uidity of the economy#
'oney supply covers 2the whole li+uidity position that is relevant to spending
decisions#2 $he spending is not limited to the amount of money in existence# &t is
related to the amount of money people thin) they can get hold of whether by receipts
of income, by disposal of assets or by borrowing#
$hus, according to this approach, money supply includes cash, all )inds of ban)
deposits, deposits with other institutions, near,money assets and the borrowing
facilities available to the people#
$he practical difficulty with this li+uidity approach is that the money supply in this
wider sense cannot be successfully measured because the degree of li+uidity of
different constituents of money supply varies considerably#
'oreover, most of the constituents remain outside the control of central ban) and
thus restrict the effective implementation of monetary policy#