Chapter 6

Money
Money is a fundamental concept in economics that plays a crucial role in our daily lives. Without
money, it would be difficult to conduct economic activity, and many of the goods and services we rely
on would be inaccessible. Understanding the role and functions of money is essential to understanding
the broader workings of the economy.

Evolution of Money
The concept of money has been around for thousands of years, and it has evolved over time. In its
simplest form, money is any item that is widely accepted in exchange for goods or services.
1. Barter System: The barter system was the earliest form of trade, where goods and services were
exchanged directly for other goods and services without the use of any medium of exchange or money.
For example, a farmer would exchange their wheat for a blacksmith's tools or services.
2. Commodity Money: As trade became more complex, people started using commodity money.
This was a form of money where valuable commodities such as gold, silver, or salt were used as a
medium of exchange. The value of these commodities was widely recognized, and they were traded in
exchange for goods and services.
3. Coinage: In ancient times, coins were introduced to make trading more efficient. Coins were
made of precious metals and had a standardized weight and size. Coins became popular because they
were portable, easy to count, and store. For example, the Roman Empire introduced the denarius coin.
4. Paper Money: Paper money was first used in China during the Tang Dynasty (618-907 AD). The
Chinese used paper money to make large purchases such as land or buildings. Paper money gradually
became popular as it was easier to carry around and use for transactions.
5. Banknotes: Banknotes were first introduced by the Bank of England in the 17th century. They
were a form of paper money that represented a promise to pay a specific amount of gold or silver.
Banknotes allowed people to carry large amounts of money without the risk of theft or loss.
6. Digital Money: With the advent of the internet and digital technology, digital money has become
increasingly popular. Digital money can be used to make online purchases, transfer money between
accounts, and even pay for goods and services in physical stores using mobile devices. Examples of
digital money include cryptocurrencies such as Bitcoin and Ethereum.

Functions of Money
1. Medium of exchange: One of the primary functions of money is to serve as a medium of
exchange. In other words, money allows us to buy and sell goods and services without having to engage
in barter.

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 For example, imagine you want to buy a new smartphone. If you had to engage in barter, you would
have to find someone who wanted to trade their smartphone for something you had to offer, such as a
bicycle or a book. But with money, you can simply pay for the smartphone with cash or a digital
payment, making the transaction much easier and more efficient.
2. Unit of account: Money also serves as a unit of account, which means it is used as a standard
measure of value for goods and services.
For example, if you go to a grocery store and see that a carton of eggs costs ₹50, you know that the
price is being expressed in terms of money. Money allows us to compare the value of different goods
and services and make informed choices about how to allocate our resources.
3. Store of value: Money also serves as a store of value, which means it can be held and used as a
way to store purchasing power over time.
For example, if you receive a paycheck for your work, you can use that money to buy things
immediately or you can save it for later. By saving money, you are storing the value of your labor for
future use. This function of money allows us to plan for the future, invest in long-term goals, and build
wealth over time.
4. Standard of deferred payment: Money also serves as a standard of deferred payment, which
means it can be used to pay debts or obligations that are incurred in the present but will be paid in the
future.
For example, if you take out a loan to buy a car, you are incurring a debt that you will have to pay off
over time. Money serves as a standard of deferred payment because it allows you to make those future
payments using a stable and widely accepted medium of exchange.
These functions are all critical to the functioning of a modern economy, and they enable us to
engage in complex economic transactions and planning with ease and efficiency.

Types of Money
Type of Money Description Examples
Currency that has intrinsic value and is made of
Full-bodied money Gold coins, silver coins
a precious metal like gold or silver
Coins made of base
Currency that has little or no intrinsic value and
Token money metals like copper and
is used as a substitute for full-bodied money
nickel, Paper Money
Currency that represents a claim on a physical
Representative full- Gold certificates, silver
commodity or other asset, such as gold or silver,
bodied money certificates
which is held by the issuing authority

Fiat Money
Fiat money is a type of currency that is not backed by a physical commodity like gold or silver, but is
instead based on the faith and credit of the government that issues it.

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 In other words, the value of fiat money comes from the fact that people believe it has value and are
willing to accept it in exchange for goods and services. This is in contrast to commodity money, which
has value because it is made of a valuable commodity like gold or silver.
An example of fiat money is the currency used in India, the Indian rupee. The value of the Indian
rupee is determined by a number of factors, including the strength of the Indian economy, the
government's monetary policies, and the demand for the rupee in international markets. As long as
people have confidence in the Indian government and its ability to manage the economy, the value of
the rupee will remain relatively stable.
One advantage of fiat money is that it allows for greater flexibility in monetary policy. Since the
government can control the supply of money, it can use monetary policy tools like interest rates and
money supply to stimulate or slow down the economy as needed. However, there is also a risk of
inflation if the government prints too much money, which can reduce the value of the currency and hurt
the purchasing power of individuals.

Legal Tender Money

Legal tender refers to any form of money that is recognized by law as a valid means of payment for
debts and taxes. In other words, if you owe someone money or taxes, they must accept legal tender
money as payment.
For example, in India, legal tender money includes the Indian rupee notes and coins issued by the
Reserve Bank of India. If you owe someone money and offer to pay with legal tender money, they
cannot refuse to accept it.
Legal tender laws are important because they help to ensure that there is a standard form of
payment that everyone can use and accept. Without legal tender laws, it would be difficult to conduct
business transactions or pay taxes, as people could refuse to accept certain forms of payment.

Non-legal Tender Money

Non-legal tender money is any type of currency or payment method that is not recognized as official
legal tender by a government.
Examples of non-legal tender money can include things like gift cards, loyalty points, and virtual
currencies like Bitcoin. While these forms of payment may be accepted by some businesses or
individuals, they are not officially recognized as legal tender by the government and cannot be used to
pay taxes or other government debts.
One advantage of non-legal tender money is that it can offer greater flexibility and innovation in the
payment system. For example, gift cards and loyalty points can be a convenient way for businesses to
incentivize customers and encourage repeat business. Virtual currencies like Bitcoin can also offer
greater privacy and security in transactions, since they are not tied to traditional banking systems.
However, there are also some risks associated with non-legal tender money. Since they are not
recognized as legal tender, they may be subject to greater price volatility or fraud. In addition, if a
business or platform that accepts non-legal tender money goes bankrupt or shuts down, customers may
be left with little recourse to recover their funds.

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Bank Money
Bank money refers to the money that exists in bank accounts, such as checking and savings
accounts. This money is created by banks when they make loans to individuals and businesses, and it is
backed by the assets that the banks hold.
When someone takes out a loan from a bank, the bank creates new money by adding the loan
amount to the borrower's account. This money is then available for the borrower to spend or transfer to
others. Similarly, when someone deposits money into a bank account, the bank is able to lend out a
portion of that money to other borrowers, creating more bank money in the process.
An example of bank money can be seen in a simple scenario where a person takes out a loan from a
bank to buy a car. Let's say the loan amount is Rs. 1,00,000. When the bank approves the loan, it adds
Rs. 1,00,000 to the person's checking account. This money is now available for the person to use to buy
the car. The bank, in turn, has created Rs. 1,00,000 of new bank money.
Another example can be seen when a business deposits Rs. 50,000 in a savings account. The bank
can use a portion of that deposit to make a loan to another business, creating more bank money in the
process.
Bank money is an important part of the modern economy, as it allows for the creation of credit and
the financing of economic activity. However, it is also important to ensure that banks are properly
regulated and have sufficient reserves to back the bank money they create, in order to maintain the
stability of the financial system.

Near Money
Near money, also known as quasi-money or quasi-liquid assets, refers to financial assets that can be
easily converted into cash, but are not themselves considered to be actual money. These assets are
typically short-term, low-risk investments that can be quickly sold or converted into cash.
Examples of near money include savings accounts, money market accounts, and short-term
government securities. While these assets are not considered to be actual money, they are still highly
liquid and can be easily converted into cash in the short-term.
One way to think about near money is to compare it to cash. Cash is the most liquid form of money,
since it can be immediately used to purchase goods and services. Near money, on the other hand, is
slightly less liquid, since it may take some time to sell or convert these assets into cash.
An example of how near money can be used is in emergency savings. If an individual wants to have
some money set aside in case of an emergency, they might choose to put their savings in a money
market account, which is considered a near money asset. While the money is not immediately available
in the form of cash, it can be quickly accessed if needed and is earning some interest in the meantime.
Another example of near money is short-term government securities. These are bonds or other debt
securities issued by the government that have a short maturity, typically less than a year. While they are
not actual money, these securities are highly liquid and can be quickly sold if needed. In fact, they are
often used as a tool by the government to manage the money supply and influence interest rates.

Cryptocurrency
Cryptocurrency is a digital or virtual form of currency that uses cryptography for secure transactions,
control the creation of new units, and verify the transfer of assets. Unlike traditional currencies issued
by governments, cryptocurrencies are decentralized and operate on a technology called blockchain.

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Key aspects of cryptocurrencies:
1. Decentralization: Cryptocurrencies are not controlled by any central authority, such as a
government or bank. Instead, they rely on a decentralized network of computers called nodes that
maintain the blockchain. This decentralized nature ensures that no single entity has complete control
over the currency.
2. Blockchain Technology: Cryptocurrencies utilize blockchain, a public ledger that records all
transactions. The blockchain consists of a series of blocks, where each block contains a set of
transactions. Each transaction is encrypted and linked to the previous transaction, creating a chain of
blocks. This technology ensures transparency, security, and immutability of the transaction history.
3. Bitcoin (BTC) was the first decentralized cryptocurrency introduced in 2009. Bitcoin operates on a
peer-to-peer network and allows users to send and receive payments without the need for
intermediaries, such as banks.
4. Mining and Verification: Cryptocurrencies like Bitcoin use a process called mining to validate and
verify transactions. Miners use powerful computers to solve complex mathematical problems, and when
they solve these problems, new blocks are added to the blockchain, and miners are rewarded with new
coins as an incentive for their computational work.
5. Digital Wallets: Cryptocurrencies are stored in digital wallets, which are software applications that
allow users to securely store, send, and receive cryptocurrencies. These wallets provide users with
unique addresses that can be used to send or receive funds.
It's important to note that while cryptocurrencies offer certain advantages such as decentralization,
security, and fast transactions, they also come with risks. These risks include regulatory uncertainties,
hacking incidents, potential price volatility and environmental concerns related to energy consumption
in cryptocurrency mining.

NFT (Non-Fungible Token):

NFT refers to a unique digital asset that represents ownership or proof of authenticity of a specific
item or piece of content. Unlike cryptocurrencies, which are fungible (interchangeable), NFTs are one-
of-a-kind and cannot be exchanged on a one-to-one basis.
NFTs have gained popularity in the art and collectibles space. Artists can create and sell digital
artwork or unique collectibles as NFTs. Each NFT has a distinct digital signature, verifying its authenticity
and ownership. NFTs are typically bought, sold, and traded on blockchain-based marketplaces.

Money Supply
The money supply refers to the total amount of money that is circulating in the economy at any
given time. This includes all the physical currency in circulation, such as coins and paper money, as well
as deposits held in bank accounts.
The money supply is important because it affects the level of economic activity in the economy.
When there is more money in circulation, people tend to spend more, which can stimulate economic
growth. On the other hand, when the money supply is tight, people may be less willing to spend and
economic growth may slow down.
One way that the money supply can change is through the actions of the central bank. For example,
if the central bank wants to stimulate economic growth, it may choose to increase the money supply by

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buying government bonds or lowering interest rates. This makes it easier for banks to lend money to
businesses and individuals, which can help boost economic activity.
Conversely, if the central bank wants to slow down economic growth and control inflation, it may
choose to decrease the money supply by selling government bonds or raising interest rates. This makes
it more expensive for banks to lend money, which can discourage borrowing and spending.

Velocity of Money Circulation

The velocity of money circulation, also known as velocity of money, refers to the speed at which
money moves through the economy. In other words, it measures how many times a unit of currency is
spent within a certain period of time.
For example, imagine you have Rs. 100 in your pocket and you use it to buy a meal from a local
restaurant. The restaurant owner then uses that Rs. 100 to buy groceries from a nearby store. The store
owner then uses that Rs. 100 to pay for utility bills, and so on. Each time the Rs. 100 changes hands, it
contributes to the velocity of money circulation.
The velocity of money is important because it helps to determine the level of economic activity in an
economy. When money is changing hands quickly, it suggests that there is a lot of economic activity
taking place and people are spending money. Conversely, when money is changing hands slowly, it
suggests that there is less economic activity and people are holding onto their money.
One way to calculate the velocity of money is by using the following formula:
Velocity of Money = Gross Domestic Product (GDP) / Money Supply
This formula takes into account the total value of goods and services produced in the economy
(GDP) and the amount of money in circulation. A higher velocity of money suggests that the same
amount of money is being used to buy more goods and services, which can help to stimulate economic
growth.

Deposits

Time Deposits: Time deposits are a type of deposit where money is deposited with a bank or
financial institution for a fixed period, ranging from a few months to several years. The money cannot be
withdrawn before the maturity date without paying a penalty.

Demand Deposits: Demand deposits are deposits that can be withdrawn by the depositor at any
time without any prior notice. The interest rate offered on demand deposits is usually lower than that
offered on time deposits.

Net Demand & Time Liability (NDTL)

Demand Liabilities are the liabilities of the bank that are payable on demand. Such as Current
Account, Savings Account, and Demand Draft.

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 Time Liabilities, on the other hand, are the liabilities of the bank that are payable after a certain
period of time. Examples of time liabilities include Fixed Deposits and Recurring Deposits.

Net Demand and Time Liabilities (NDTL) is the sum total of the demand and time liabilities of a bank
that are held by the public.

Measure of Money Supply

In India, there are four main measures of money supply that are tracked by the Reserve Bank of
India (RBI). These measures are known as M1, M2, M3, and M4. Let's take a closer look at each one:

M1: This is the narrowest measure of money supply in India, and it includes only the most liquid
forms of money.

M1 = currency in circulation + demand deposits held by commercial banks

M2: This is a broader measure of money supply that includes all the components of M1, as well as
some less liquid forms of money.

M2 = M1 + savings deposits with Post Office.

M3: This is an even broader measure of money supply that includes all the components of M1, as
well as some other types of deposits.

M3 = M1 + Net time deposits of commercial banks.

M4: This is the broadest measure of money supply in India, and it includes all the components of
M3, as well as some other financial assets. In addition to currency in circulation, demand deposits,
savings deposits, and time deposits, M4 also includes all post office deposits and all deposits with non-
banking financial companies (NBFCs). In equation form,

M4 = M3 + all post office deposits + all deposits with NBFCs.

These measures of money supply are important for the RBI and other policymakers to track, as they
can indicate changes in the overall money supply in the economy and help inform decisions about
monetary policy.

Reserve Money (also known as High-Powered Money or Primary Money)

Reserve money, also known as base money or high-powered money, refers to the total amount of
currency and reserves held by the central bank of a country.
In India, the central bank is the Reserve Bank of India (RBI), and it holds reserves of various types of
money, including cash reserves held by commercial banks, deposits held by commercial banks at the

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RBI, and other types of reserves. These reserves are used by the RBI to implement monetary policy,
regulate the banking system, and maintain financial stability.
The formula for reserve money is:
Reserve Money = Currency in Circulation + Bankers' Deposits with RBI + Other Deposits with RBI +
RBI's Other Liabilities
where:
- Currency in Circulation refers to the total amount of physical currency (coins and banknotes)
circulating in the economy. This includes both the currency held by the public and by commercial banks.
- Bankers' Deposits with RBI refers to the deposits made by commercial banks with the RBI, which
serve as a reserve requirement for the banks.
- Other Deposits with RBI includes deposits made by the government, state governments, and other
entities with the RBI.
- RBI's Other Liabilities includes other types of liabilities held by the RBI, such as deposits held by
foreign central banks and international organizations.
An example of how reserve money works is as follows:
Suppose the RBI wants to increase the money supply in the economy. It can do this by purchasing
government securities from commercial banks, which increases the amount of reserves held by the
banks. This in turn increases the amount of deposits the banks can make with the RBI, which increases
the reserve money in the economy.
For example, if the RBI purchases government securities worth Rs. 1,000 crore from commercial
banks, the banks will have an additional Rs. 1,000 crore in reserves. They can then deposit this money
with the RBI, which increases the RBI's liabilities and thus the reserve money in the economy.
Overall, reserve money is an important concept in economics and monetary policy, as it plays a key
role in determining the money supply and regulating the banking system.

Money Multiplier

The Money Multiplier measures the amount of money that the banking system can create through
the process of credit creation. It is defined as the ratio of the money supply to the Reserve Money,
which is the base level of money supply in the economy.

Money Multiplier (m) = Money Supply / Reserve Money

The Money Multiplier measures the speed at which credit is being created in the economy. When
the Reserve Bank of India (RBI) injects money into the banking system, commercial banks use a portion
of that money to make loans to households and firms. This process of credit creation increases the
money supply in the economy.

The Money Multiplier indicates the potential increase in the money supply that can result from an
increase in the Reserve Money. For example, if the Reserve Money increases by Rs. 1000 crore and the
Money Multiplier is 2, then the money supply can potentially increase by Rs. 2000 crore (i.e., 1000 x 2).

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 The credit creation process can lead to an increase in the Money Supply, and this can result in
inflationary pressures in the economy if it is not matched by an increase in the production of goods and
services. Therefore, the RBI closely monitors the credit creation process and uses monetary policy tools
to regulate the money supply in the economy and maintain price stability.

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