UNIT 1 :
Concepts & functions of Money,
origin and development of money,
limitations of barter system,
classification of money,
importance of money,
qualities of good money,
defects of money
Money is a liquid asset used to facilitate
transactions of value. It is used as a medium of
exchange between individuals and entities. It's
also a store of value and a unit of account that
can measure the value of other goods.
Money is any object that is generally accepted
as payment for goods and services and
repayment of debts in a given country or socio-
economic context. The main functions of money
are distinguished as: a medium of exchange; a
unit of account; a store of value; and,
occasionally, a standard of deferred payment.
4 symbolic terms are used by RBI :
M1, M2, M3 and M4
M1 = Narrow money = cash + Demand
deposits + Other deposits with RBI (
M2= Extension to M1 = M1+ POSBD (Post
office savings bank deposits ) relatively less
liquid than M1M3= Broad money
M3= M1 + TD ( Time deposits)
M4= extension to M3 = M3+ TPO ( Total post
(i) Money as a Medium of Exchange:
removes the need for double coincidence of wants and the
inconveniences and difficulties associated with barter.
separates the transactions in time and place because the sellers
and buyers of a commodity are not required to perform the
transactions at the same time and place.
Provides the freedom of choice. With money, we can buy an
assorted bundle of goods and services. At the same time, we can
purchase the best and also bargain in the market.
Thus money gives us a good deal of economic independence and
also perfects the market mechanism by increasing competition
and widening the market.
money acts as an intermediary. It facilitates exchange.
According to Prof. Walters, money, therefore, serves as a ‘factor
of production,’ enabling output to increase and diversify.
money facilitates trade. When acting as the intermediary, it
helps one good or service to be traded indirectly for others.
(ii) Money as Unit of Value
Monetary unit expresses the value of each good or service in terms of
price. Money is the common denominator which determines the rate
of exchange between goods and services which are priced in terms of
the monetary unit.
The use of money as a standard of value eliminates the necessity of
quoting the price of apples in terms of oranges, the price of oranges
in terms of nuts and so on.
Solves the problem of measuring the exchange values of goods in the
market. When values are expressed in terms of money, the number of
prices are reduced from n(n-l) in barter economy to (n-1) in
monetary economy.Money as a unit of value also facilitates
accounting. “Assets, income and expenses of all kinds can be stated
in terms of common monetary units
It helps in all types of economic and financial calculations
As pointed out by Culbertson, “Prices quoted in terms of money
become the focus of people’s behaviour. Their calculations, plans,
expectations, and contracts focus on money prices.”
(i) Standard of Deferred Payments:
Money as a standard of deferred payments means
that money acts as a ‘standard’ for payments, which
are to be made in future.
Every day, millions of transactions take place in
which payments are not made immediately. Money
encourages such transactions and helps in capital
formation and economic development of the
This function of money is significant because:
1. Money as a standard of deferred payments has
simplified the borrowing and lending operations.
2. It has led to the creation of financial institutions.
(ii) Store of Value (Asset Function of Money):
Money can be used to transfer purchasing power from present to
future. Money is a way to store wealth in most economical and
It provides security to individuals to meet contingencies,
unpredictable emergencies and to pay future debts. Under barter
system, it was difficult to use goods as a store of wealth due to
perishable nature of some goods and high cost of storage.
Money as store of value has the following advantages:
1. Money is available in fractional denomination = shinplasters
(united states federal govt. /civil war)
2. Money is easily portable. So, it is easy and economical to store
money as its storage does not require much space.
3. Money has the merit of general acceptability so; it can be
easily exchanged for goods at all times.
4. Savings in terms of money are much more secured than in
terms of goods.
(iii)Transfer of Value:
Money also functions as a means of transferring
value.Through money, value can be easily and quickly
transferred from one place to another because money is
acceptable everywhere and to all.
For example, it is much easier to transfer one lakh rupees
through bank draft from person A in Amritsar to person B in
Bombay than remitting the same value in commodity
terms, say wheat.
1. Distribution of National Income:
Money facilitates the division of national income between
Total output of the country is jointly produced by a number of
people as workers, land owners, capitalists, and
entrepreneurs, and, in turn, will have to be distributed
Money helps in the distribution of national product through
the system of wage, rent, interest and profit.
2. Maximization of Satisfaction:
Money helps consumers and producers to maximize their
A consumer maximizes his satisfaction by equating the prices
of each commodity (expressed in terms of money) with its
Similarly, a producer maximizes his profit by equating the
marginal productivity of a factor unit to its price.
3. Basis of Credit System:
Credit plays an important role in the modern
economic system and money constitutes the
basis of credit.People deposit their money
(saving) in the banks and on the basis of
these deposits, the banks create credit.
4. Liquidity to Wealth:
Money imparts liquidity to various forms of
wealth.In fact, all forms of wealth (e.g.,
land, machinery, stocks, stores, etc.) can be
converted into money.
Barter is an alternative method of trading
where goods and services are exchanged
directly for one another without using
money as an intermediary. It is an old
method of exchange. People exchanged
services and goods for other services and
goods in return.
1. Lack of Double Coincidence of Wants
2. Lack of a Common Measure of Value
3. Indivisibility of Certain Goods
4. Difficulty in Storing Value
5. Difficulty in Making Deferred Payments
6. Limitations of portability
Animal money: in historic period 'animal
money' was used as a means of exchange, e.g.
cow sheep goat etc. however due to their
indivisible nature, commodity money came into
Commodity Money:In the earliest period of
human civilization, any commodity that was
generally demanded and chosen by common
consent was used as money.Goods like furs,
skins, salt, rice, wheat, utensils, weapons etc.
were commonly used as money. Such exchange
of goods for goods was known as ‘Barter
sometime around 1,100 B.C., the Chinese moved
from using actual tools and weapons as a
medium of exchange to using miniature replicas
of the same tools cast in bronze.
Nobody wants to reach into their pocket and
impale their hand on a sharp arrow so, over
time, these tiny daggers, spades and hoes were
abandoned for the less prickly shape of a circle,
which became some of the first coins.
Although China was the first country to use
recognizable coins, the first minted coins were
created not too far away in Lydia (now
With progress of human civilization,
commodity money changed into metallic
Metals like gold, silver, copper, etc. were
used as they could be easily handled and
their quantity can be easily ascertained.
It was the main form of money throughout
the major portion of recorded history.
It was found inconvenient as well as
dangerous to carry gold and silver coins from
place to place .So , invention of paper
money marked a very important stage in the
development of money.
Paper money is regulated and controlled by
Central bank of the country (RBI in India).At
present, a very large part of money consists
mainly of currency notes or paper money
issued by the central bank.
Emergence of credit money took place
almost side by side with that of paper
money.People keep a part of their cash as
deposits with banks, which they can
withdraw at their convenience through
cheques.The cheque (known as credit money
or bank money), itself, is not money, but it
performs the same functions as money.
Banks have been around since the first currencies
were minted, perhaps even before that, in some form
or another. Currency, particularly the use of coins,
grew out of taxation. In the early days of ancient
empires, a tax of one healthy pig per year might be
reasonable, but as empires expanded, this type of
payment became less desirable. Additionally, empires
began to need a way to pay for foreign goods and
services, with something that could be exchanged
more easily. Coins of varying sizes and metals served
in the place of fragile, impermanent paper bills.
The First Bank
The Romans, great builders and
administrators in their own right, took
banking out of the temples and formalized it
within distinct buildings. During this time
moneylenders still profited, but most
legitimate commerce, and almost all
governmental spending, involved the use of
an institutional bank.
“Charg-it” was the first actual bank card and
was issued in 1946.The card was invented by a
banker in Brooklyn, by the name of John Biggins.
However, only local purchases could be made.
later on American Express and Bank of America
(BANK AMERICARD) introduced credit cards in
Later on IBM attached Magnetic stripe to the
cards.The ATM (Automated Teller Machine) was
brought into existence in the 1960’s by John
Shepperd-BarronVisa and Mastercard took the
plastic money to international level in early 70s.
In 1983, David Chaum from USA founded a
company Digicash.In 1997, Coca-Cola offered
buying from vending machines using mobile
payments and PayPal emerged in Before that
E-gold was established in 1996 which
promoted digital currency backed by
Gold.Mobile wallets evolved simultaneously
from 2005 ( Spain – Mobipay) to Google
Wallet in 2011
A crypto currency is a type of
digital token that relies on cryptography for
chaining together digital signatures of token
transfers, peer-to-peer networking
and decentralization of currency.A
transaction is a transfer of value
between Bitcoin wallets that gets included in
the block chain. Bitcoin wallets keep a secret
piece of data called a private key or seed,
which is used to sign transactions, providing
a mathematical proof that they have come
from the owner of the wallet.
Fiat money gets its value from a government
order (i.e. fiat). That means, the government
declares fiat money to be legal tender, which
requires all people and firms within the country
to accept it as a means of payment. Unlike
commodity money, fiat money is not backed by
any physical commodity.Its intrinsic value is
significantly lower than its face value. Hence,
the value of fiat money is derived from the
relationship between supply and demand.
In fact, most modern economies are based on a
fiat money system.
Fiduciary money is money that is accepted
as a medium of exchange due to the trust
that exists between the payer and the
payee. Cheques and bank notes are
examples of fiduciary money because they
are both tokens that are used as money and
have the same value.
Fiduciary money depends for its value on the
confidence that it will be generally accepted as
a medium of exchange.
Unlike fiat money, it is not declared legal tender
by the government, which means people are not
required by law to accept it as a means of
Instead, the issuer of fiduciary money promises
to exchange it back for a commodity or fiat
money if requested by the bearer.
As long as people are confident that this promise
will not be broken, they can use fiduciary money
just like regular fiat or commodity
money. Examples of fiduciary money
include cheques or drafts.
Medium of exchange,
store of value,
standard for deferred payments,
transfer of value,
imparts liquidity to wealth,
distribution of National Income
Helps consumers gain maximum satisfaction by
equalizing marginal utility with price
Basis of capital formation and investments
Instrument and index for socio-economic growth
Provides base for accounting and financial
Facilitates national as well as International trade
Universal acceptability Difficult to duplicate
Supported by respective government
Effectively supervised by monetary authority
Economic Defects Unstable in value
Unequal distribution of wealth and income
Over and under issue of money
Creates social hierarchy and social imbalance
Improper utilization of money : speculations,