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Introduction to money

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Introduction to money

  1. 1. Introduction to Money PREPARED BY UMAIR
  2. 2.  Barter System  Commodity Money  Metallic Age  Paper Money
  3. 3. In barter age there was no money. The trade used to take place without any money. Goods were exchange for goods and there was a problem of double coincidence of wants.
  4. 4. As the society developed people found that they need some commodities more than others and their wants are of varying importance. This increased the importance of some commodities and goods. Gradually these commodities attained the status of money in that era. People used to value these higher than others. So we can say that different goods or commodities became money in that era.
  5. 5. Man found gold, silver and other precious metals.
  6. 6. The people were in the habit of keeping these gold coins, and bars with goldsmiths. The receipts issued by goldsmiths become medium of exchange over time.
  7. 7. “Barter is the direct exchange of commodity or service for another without the use of money.”
  8. 8.  Double coincidence of wants.  No Measure of Value  No subdivision  No store of Value  Standard of Deferred Payments  No investment /Savings  Economic Measurements  Comparison of Living Standard  Tax Collection  Difficulties in Transfer of Wealth  No Specialization  No Budgeting  No Capital Formation
  9. 9. Surplus sugar with you and you need a leather jacket.
  10. 10. Measure value of different units or to measure value of different goods.
  11. 11. There is always a problem of lack of subdivision. (e.g., horses cattles).
  12. 12. Under barter, wealth can’t be stored for a longer period of time. Goods which were perishable couldn’t be sorted for any longer time period.
  13. 13. There was no mechanism to state debts and payment in future with reasonable certainty and security.
  14. 14. People were in the habit of self-sufficiency and they were not able to save for rainy days or to invest what they have got in surplus to earn healthy returns.
  15. 15. There was no system to measure personal income on micro level and GDP on macro level.
  16. 16. As under barter, wealth can’t be stated in common units, so it was impossible to compare living standers of different classes of society.
  17. 17. Under barter it is extremely difficult if not impossible to impose any type of duties and taxes and then to collect them.
  18. 18. Mostly people were in the habit of holding wealth in form of animals and perishable goods and it was not an easy task to transfer them over longer distances.
  19. 19. In barter system there are no incentives for specialization. People usually try to attain self sufficiency and this does not make efficient allocation of resources.
  20. 20. There are no incentives for budgeting expenses and incomes.
  21. 21. Under barter, there are no incentives for savings and production of a capital goods.
  22. 22.  Medium of Exchange  Store of Value  Price Mechanism  Credit and Advances  Banking institutions  Investment & Savings  Public Finance/ Government Revenues.  Ease of Specialization  Foreign Investment  Measurement of Efficiency
  23. 23. Money serve as a common medium of Exchange. It eradicates the inconvenience of “double coincidence of wants.” Now anyone can buy anything and sell anything for money.
  24. 24. Inconvenience of “Lack of store of value.”
  25. 25. It remove the inconvenience of “no measure of value.”
  26. 26. Has removed the inconvenience of “no Standard of deferred payment”.
  27. 27. Money has greatly helped in the establishment, working and development of all banking and monetary institutions.
  28. 28. Money has made it possible and extremely easy to invest and save. Now we can save our wealth by investing it in different saving schemes.
  29. 29. Money has greatly helped the accounting of public finance, tax revenues and government revenues etc.
  30. 30. Barter was characterized by the phenomena of self sufficiency which was inefficient.
  31. 31. Money has made possible the huge foreign investment in today’s world. Under barter system, investment was fairly impossible.
  32. 32. Under barter, there was no standard of measuring efficiency and productivity. However, this problem was solved by money.
  33. 33.  Commodity Money  Metallic Money  Paper Money  Bank Money  Plastic Money  Other Forms
  34. 34. Commodity money cab be thought of as the earliest form of the money. In ancient times money was in the form of different goods that were commonly used by people in everyday life.
  35. 35. Metallic money comes next to commodity money. As the name suggest, it consists of different metals such as gold, silver and iron etc. a) Full Bodies money: It means that the piece of metal that is used as a money has the same intrinsic and face value. b) Token Money: It means such a money whose intrinsic value is less than its face value.
  36. 36. Paper money means the currency notes issued by the central bank of country. There are three forms of paper money.
  37. 37. a) Representative Paper Money: Representative paper money is one which is fully backed by gold or metallic reserves. b) Convertible Paper Money: It is such a form of money which can be converted into gold and metallic reserves but not all the notes issued by the govt. c) Fiat Paper Money: Fiat paper money is one that we have got in our pockets. Neither it is convertible, nor it is fully backed by gold or metallic reserves.
  38. 38. Bank money means near money, which is not always legal tender but it is widely accepted as a medium of exchange.
  39. 39. A cheque is a written instruction on a specified piece of paper from a client to his bank, instructing the later to pay a certain sum of money.
  40. 40. Bill of exchange is a convenient way to pay for commercial transaction in credit. The seller instead of taking cash from the buyer draws a bill on him which the buyer accepts by signing it.
  41. 41. Draft is just like a cheque. However, the difference is that it is drawn by a bank on its own branch or on any other bank’s branch.
  42. 42. Plastic money means the credit cards and plastic cards which have silicon chips and a specially printed set of characters.
  43. 43. a)Black Money: Black money is one which has been gathered through illegal means. b)White money: White money is one which has been earned though legal and legitimate means. c) Cheap Money: Cheap money is one whose cost of borrowing is less than the standard rate of interest.
  44. 44. Merits: 1. Full Safety The principal is 100% safe as there is 100% backing. 2. No over issue: The system will restrict the central authority form over issuing notes. 3. Stability: The 100% backing gives an element of stability to this system. 4. Confidence: As already stated the currency issued under this principal enjoys a complete confidence public.
  45. 45. Demerits: 1. Inelastic: This system is highly inelastic and rigid. 2. No use of Gold: Further this system makes an inefficient use of gold. 3. Not suitable for Modern Economy: The currency principal is not suitable for modern economy.
  46. 46. Merits: 1. Elastic Supply The principal gives an elastic supply of currency. 2. Economical: This principal is economical in a sense that only a percentage of notes issued are backed by gold. 3. Usage of Gold Reserves: This system allows the govt. or issuing authority to make effective and efficient usage of gold and metallic reserves. 4. Public confidence: This system also enjoys a good degree of public confidence just like the currency principle. 5. Suitable for Modern Economy: This principle is suitable for the needs of modern economy. It is flexible and elastic and more responsive to change in economic climate. 6. Helpful in Emergency: This principle is helpful in emergency. Print notes without keeping 100% reserves.
  47. 47. Demerits: 1. Danger of Over issue: The danger of over issue always exists in this principle. As no 100% backing is required so there is a tendency towards issuance of notes which may lead to inflation that can be disastrous for the economy. 2. Lack of Convertibility: As there is no hundred percent banking. Occur in a very unlikely situation.
  48. 48. 1. Fixed Fiduciary Issue: Under this system a limit of volume of currency has been fixed by central authority. However any note issued above this limit are to be 100% backed by gold.
  49. 49. Merits a) Controlled Supply: Under this system the supply of currency note be held under control. b) No Danger of Over issue: Under this system, as notes issued above a particular limit are to be 100% backed , so there is not a danger of over.
  50. 50. Demerits: a) Inelastic: This system was adopted by England in 1844 but it was subsequently abandoned in 1913. This means that if economy is rapidly developing then there will be increasing demand for the currency and credit. At this moment if required volume of gold is not available than bank will not be able to issue notes.
  51. 51. Under this system the central bank is required to keep 100% reserves for a particular percentage of notes issued.
  52. 52. a) A Widely Prevailed System This system remained in force in many parts of the world for different time period. b) Elastic: This system is elastic in a sense that if economy is under expansion then naturally there will be a need to expand the currency and credit. c) High Degree of Safety: This system is safer and more sound as compared to others. In this system the chances of over-issue of currency are less and so there is less danger of unwanted inflation. d) Responsive: This system has higher degree of responsiveness.
  53. 53. a) Rigid: This system is rigid. As notes cannot be issued over a particular limit without keeping Government securities. b) Contraction in Money Supply: An other disadvantage is that governments some times have to do unwanted contractions n money supply.
  54. 54. Under the Minimum Reserve system method of note issue the central bank has to keep only a minimum amount of reserves, against all the notes issued.
  55. 55. a) Elasticity: The important merit of this system is elasticity. b) Responsive: This system has higher degree of responsiveness than other systems. This means that if economy demands increase in the supply of currency then under this system appropriate immediate response. c) Safety: This system enjoys higher degree of safety. The central monetary authorities keep a close eye on the state of affairs of the economy. d) Suitable for Modern World. This system is widely practiced in different modern economies. This system caters to the needs of the growing developed economies.
  56. 56. a) Inconvertibility The demerit is that the paper currency under this method is absolutely inconvertible. b) No Intrinsic Value Major disadvantage is that currency issued under this system has no intrinsic value.
  57. 57. Primary Functions: 1. Medium of Exchange Money serves as a medium of exchange. It is used to make payments for goods and services. 2. Standard of Value Money serves as a standard of value. The goods services of modern world are priced and valued in terms of money. 3. Store of Value: Money is also the store of value. It can be saved for use in future. In the form of money, purchasing power can be stored to buy goods in future. 4. Standard of Deferred Payment. Money is a standard of deferred payment. It is used to express debt and business obligations.
  58. 58. 5. Market Mechanism: Money is at the base of market mechanism. In other words market mechanism and the forces of demand and supply works only because of money. 6. Income and Consumption: All economic variable including income and consumption are determined and quoted in terms of money. 7. Instrument of Modern Economy Money is the basic and most important instruments of modern economy. All he economic policies are applicable only because of the fact that it is possible to state the price of everything in term of money. 8. Monetary and Fiscal Management. Money is an important element of monetary and fiscal policies of government. It plays its role in all kinds of economic actions taken by government.
  59. 59. 9. Aids to Economic Activities. All kinds of economic activities such as investments, savings, credit, advances, purchases, sales are made in term of money. 10. Specialisation and Trade: Money has made specilisation possible. Previously, there was a concept of self sufficiency. But in today’s world, nation tend to specialise in the production of things in which they have comparative advantage. 11. Liquidity to International Trade Money has provide the liquidity to international trade. The wealth can be transferred readily from one country to another.
  60. 60. 12. Basis for Economic Theories Money is the basis for almost all economic theories. The consumption theory, production theory, utility theory, etc are all applicable because of the function of money. These theories cannot be applied to a moneyless or barter economy. 13. Determination/ Distribution of NI: With the help of money it is possible to determine national income and to analyse its distribution among various classes of society. 14. Efficiency and Optimum Allocation: Due to money it is possible to evaluate different efficiency levels. The cost of resources stated in money terms is equated with the price of the product to determine allocative and productive efficiency.
  61. 61. 15. Basis of Credit: Money lies in the roots of banking credit system.
  62. 62. 16. Measure of Liquidity: With money it is possible to measure the liquidity of anything. 17. Determination of Solvency: Money is used to determine the solvency of any firm or company etc. To analyse that whether a business is able to pay off its debts, money value of all of its net asset is taken into consideration. 18. Difference uses: Money is suited for many different types of uses. It is used by consumer in variety of ways to get satisfaction.
  63. 63. 1. General Acceptability: The good money is one which is generally acceptable by all without any hesitation. 2. Stability: The value of money should stay stable otherwise people will loose confidence over it. 3. Standardized: The good money is of standardized nature and quality of its material does not undergo any great change. 4. Economical: The issuances of good money should always be economical.
  64. 64. 5. Storability: A good money is one in the shape of which purchasing power can be stored for a longer period. 6. Divisibility: A good money is capable of being divided into smaller denominations. 7. Transportability: A good money is easily transferable form one place to another. 8. Recognizable: Good money is one that can be easily recognized by seeing or touching. 9. Difficult to copy: A good money is one which is very difficult to be copied.
  65. 65. 10. Easily Meltable: A good currency can be conveniently kept and stamped. Malleability is mainly a quality of metal coins. 11. Elasticity: The supply of money should remain elastic. It means that it should respond to the general needs of the economy. 12. Element of Supervision. A good money is one that can be effectively supervised by a central monetary authority. 13. Scarcity: A good money should be scarce in quantity. Its quantity in the economy should kept low as compared to the desire for it. Conclusion: These are the characteristics of an ideal money. The paper currency conforms to majority.
  66. 66. 1. Spending & Consumption: The quantity and stock of near money directly affects the spending and consumption volume of the economy. When the amount of near money is high this means people have less of perfectly liquid money. 2. Inflationary Trends: Quantity of near money and their conversion directly affects trends of economy. If during boom period, people convert their near money in perfectly liquid money. 3. Economic Polices: Near money are also important determinant of economic policies. If there are inflationary trends in the economy, government increases the interest rate.
  67. 67. 4. Liquidity Preference: Near money is also an important factor of liquidity preference theory of Keynes. According to this theory the quantity of near money in the economy has an important bearing on the rate of interest and the equilibrium quantity of money supply. 5. Use of Security: Near money are also used as security to obtain loans and credits from banks and other financial institutions.
  68. 68. Paper money means the paper instruments such as bank notes, cheques, bills, and other forms which act as a currency.
  69. 69. 1. Economical: Paper currency is very economical to issue. The cost of currency as compared to its face value is very low. Printing of paper currency requires certain special type of paper ink and printing technology. 2. Unlimited Legal Tender: Paper currency is unlimited legal tender i.e., any amount of debt can be paid in it. It can be used to discharge all kinds of business obligations and liabilities. 3. Elasticity in Supply: The supply of paper currency is elastic. It can be increased or decreased according to monetary situation. 4. Convenience: The paper currency is convenient to carry and transfer. It can be easily kept in pocket or wallets. 5. Difficulty to Copy. The design of paper currency is very intricate and special type of paper and ink is used hence it is impossible to copy it.
  70. 70. 6. Uniformity: the paper currency stays uniform. The apparent loss of colour or tearing of paper does not effect he face value. 7. Growths & Development: The present era of economic prosperity and development owes great to the paper currency. Paper currency is at the base of world’s vast economy. 8. Price Mechanism: Our market forces of demand and supply works because of the price mechanism. Paper currency has greatly helped in making price mechanism workable and effective. 9. International Trade: The present state of international trade also owes great to paper currency. 10. Monetary Management: As the supply of paper currency can be regulated by central bank thus monetary management becomes easy. 11. Record: Paper Currency is always numbered. Each note has a distinct number.
  71. 71. 12. Ease of Counting: The Paper money can be easily counted and piled up in bundles. 13. Convertibility: Paper currency is easily convertible into other credit instruments such as drafts, promissory notes, bills etc. 14. Saving in the use of Metal: Paper currency indirectly leads to the saving in the metallic reserves of the country. 15. Ease of issuance: The paper currency is easy to issue and administer. There are different methods for the issuance of Paper currency.
  72. 72. 1. Inflation: The major disadvantages of paper currency is that it is exposed to inflation. The face value remains unchanged but the purchasing power decline. 2. Danger of Over issue: As the supply of currency is elastic and is under the control of the Central Bank so there is a danger of over issuance. 3. Demonetization: Paper currency can any times be demonetized by the State. Under such case it does not remain legal tender and no body accepts it. 4. Monetary Mismanagement: Purchasing power of paper currency is volatile (meaning it evaporates) in nature.
  73. 73. 5. Price Instability: Paper currency has given rise to wide scale price fluctuations in different countries of world. 6. Limited to Country. The use of paper currency is limited to its issuing country. 7. Loss Due to Fire or Water. Although the paper currency is not affected by any apparent wear and tear or loss. 8. Uncertainty: Paper currency has no value of its own. All the commands is because of its status as a legal tender. Summing Up: Paper Currency is by far the most commonly used form of money in today’s world. The basic reason of this is the ease with which it can be used an managed by all.
  74. 74. 1. Production: Starting with the production, the producer produces because of profit motive which is expressed completely in terms of money. 2. Consumption: In capitalistic society, consumer is a king, free to make choice about what he should consume. The consumption depends on income. Both the income and consumption expenditures are stated in terms of money. 3. Pricing of Factors of Production: The money has made it possible to evaluate the human effort and thus to determine its wage or reward. 4. Pricing of Environmental Factors: Money has helped in pricing and thus determining the importance of environmental and natural resources.
  75. 75. 5. Penalties of Environmental Deterioration: It is evident that you can’t assign value to fresh clean water, clean environment. These are all precious things. 6. Calculation of Macro Economic variables: Money has mad it possible to calculate and determine different macro-economic variables such as GDP, GNP, NI, etc. 7. Distribution of National Income: The distribution o NI is also based on money. Government with the help of money can distribute resources among various poor sectors of the economy. 8. Public Finance: The tax collection and the imposition of new taxes are possible just because we have money in our economy. 9. Borrowing and Debt Servicing: The loan that you take form your friend and the borrowing of the government form IMF, all these are possible only because there is money.
  76. 76. 10. Satisfaction and Optimal Use of Resources. Money is important as it helps in determining the standard of satisfaction and optimal allocation of resources. 11. Working of Banks & Financial Institutions: Money is the basis for the functions and operations of banks and financial institutions. 12. International Trade: Money has also greatly expanded the international trade. The difference between costs of production among various parts of world can be calculated as we have got money to value scarce as well a abundant resources
  77. 77. 13. Industrial Resolution: It made possible the valuation of different resources so that they can be used in the most profitable way. It also helped in the valuation of certain professional services such a as lawyers, auditors etc. 14. Government: Money is perhaps the basic need of the governments besides lot of others. Governments need money to perform all such functions as maintenance of law and order.
  78. 78. Money no doubt has contributed very effectively and generously towards modern economy. However at the same time it has produced certain world wide ‘ills’ and ‘bads’. These are explained below.
  79. 79. 1. Class Conflict: Money has given rise to the class conflict. It has made some people very rich at the expense of million of others. This fact is also the cause of widespread disturbance and crimes in the modern world. The money has greatly helped to increase interaction among lots of people but at the same time it has created a very dangerous distinction between people. 2. Trade Cycle Trade cycle are also an outcome of mismanagement of money (monetary) forces. Trade cycles not only effe4ct industrialists or land lords but they do equal harm to poor and ordinary people.
  80. 80. 3. Inflation: It is natural that a thing that is chosen as a standard must be free of nay alternation. But although money has been chosen as a standard of value yet it itself is subject to inflation. 4. Debt Traps: The money has made some nations debtors and other creditors (again note that money itself has not done). The debtor countries are forced to implement heavy taxes and penalties on their poor people to accumulate money to pay off these debts. 5. Domination of Multinationals: The money economy has resulted in concentration of wealth in few hands. The multinationals have taken hold of the major proportion of whole world’s trading and business.
  81. 81. 6. Environmental Degradation: The greed of money has made man so selfish that he is collection wealth at the cost of the well being of his future generations. 7. The Credit Economy: The availability of money has considerably contributed to the expansion of credit throughout the economies.
  82. 82. 1. Greed: The amenities of new world has increased the greed of men. 2. Crime: As already stated money has made some people very rich at the expense of others. This has resulted in widespread deprivation. 3. Exploitation: The rich are exploiting poor masses in different ways. The money is the most commonly used instrument for such exploitations. They intentionally vote for such policies that are aimed at making them more rich and comfortable. 4. Gambling: It is said that “Easy Come Easy Go”. So is the case with rich people of this world. As their wealth is increasing day by day they are in need of some way out to spend lavishly.
  83. 83. 5. Diseases: The lust of money besides making people psychologically ill has also contributed to numerous physical aliments and miseries. 6. The Drug Trade: The greed of money has given rise to huge under ground economy. Drug trade is perhaps the biggest of such activity. 7. Corruption: Corruption is the world with which we rare most familiar. Corruption, malpractices, kick back, money laundering can be thought of as different names of the single desire of becoming more and more rich. Conclusion: The monetary, fiscal and socio-economic problems that world is facing today have made economists to think about the welfare state.