MoneyChapter No # 1

Nature & Functions

Of Money

Terms to know:

Inconveniences of Barter system

Definition of money

Meaning of Barter system

Functions of money

Evolution of Money

Quality of Good Money

Meaning of Barter:

There was a time when money did not exist,

people used to exchanges goods for goods.

Such a system for exchange of goods without the use of money is called barter.

Or The direct exchange of goods for other

goods is called barter.

Example:

A horse may be exchanged for a cow, or 3 sheep or 4 goats.

Thus a barter economy is a moneyless economy. It is also a simple economy where people produce goods either for self-consumption or for exchange with other goods which they want.

This system found in Primitive Societies (Simple way living).

Inconveniences of Barter system

Difficulties Difficulties In Barter In Barter systemsystem

BB

EE

CC

DD

AALack of double coincidence of

wants

Lack of common measure of values

Lack of store of values

Indivisibility of Certain Goods

Payments in the future

Inconveniences of Barter system:

Lack of double coincidence of wants:

First difficulty was that… exchange of goods can take place

b/w two persons only if each posses the good which the

other wants.

Lack of common measure of value:

If incidentally two persons met together who wants each

other goods, they could not find a satisfactory value of their

goods, under such circumstances one party has to suffer.

Lack of store of value:

Goods cannot be stored for a long time, because their

Value decreases as time passes.

Inconveniences of Barter system (continued):

Payments in the future:

Under the system of barter, it is very inconvenient to lend

goods to other people. With the lapse of time, the value of

the commodities may fall.

Indivisibility of Certain Goods:

Barter system is based on the exchange of goods with

other goods. It is difficult to fix exchanges rates for certain

goods which are indivisible.

Evolution of Money

Evolution of Money

The word “Money” is derived from the Latin word

“Moneia” which was the Surname of the Roman goddess

of Juno in whose temple at Rome, money was coined.

The type of money in every age depended on the nature

of its “Livelihood”.

In a hunting society, the Skins of wild animals were used

as money.

The Pastoral society used livestock, whereas the

agricultural society used Grains and foodstuffs as money

The Greeks used Coins as money.

Money throughout the history of the world

Shells

Live stock

Precious stones

Skulls

Pearls

Wheat

Feathers

Brass

Silver

Gold

Paper money

Stages in the Evolution of Money

5 stages of Money Evolutions

Evolution Stages

NearMoney

CommodityMoney Metallic

Money

PaperMoney

CreditMoney

1st

2nd

3rd

4th

5th

Commodity Money

Various types of commodities have been Various types of commodities have been used as money from beginning of human used as money from beginning of human civilization, civilization,

Cow Heads, Goats, Axes, skin, Dried Fishes Cow Heads, Goats, Axes, skin, Dried Fishes etc were used as medium of exchange.etc were used as medium of exchange.

Commodity Money

One of the most unusual forms of money was the stone used by primitive peoples on the island of Yap in the South Pacific until the early 20th century. Their money, called the fei, consisted of large stone wheels ranging in size from 1 to 12 feet (0.3-3.6 meters) in diameter with a hole in the center. The larger the stone the greater was its value. Since many of these stones were massive and difficult to move, they remained at a given location, although their ownership changed hands

Difficulties in commodity money

All commodity were not uniform in quality.

Difficult to store and prevent loss of value.

Lacked in portability

Problem of indivisibility

METALLIC MONEY MONEY

The next step in the evolution The next step in the evolution was the discovery of precious was the discovery of precious metals.metals.

Cont….

With spread of civilization and trade relation by land, sea, metallic money took the place of commodity money.

Many nations started using Silver, Gold, Copper, tin etc.. As Money.

Metal was made into coins of predetermined weight. This innovation is attributed to King Midas Of Lydia in the eight (8th) century.

PAPER MONEYPAPER MONEY

PAPER MONEY HISTORY PAPER MONEY HISTORY

It is believed that the first paper money was printed by the Chinese in the early part of the 9th century a. d. Marco Polo, on his return from China in 1295, wrote about the paper money issued by Kubla Khan. This money was a black, paper like substance made from the thin skin of the mulberry tree

When paper money start

960- Issues of Chinese paper money start to become regular

1659 The earliest British cheque is issued This is an order to the London goldsmiths Morris and Clayton to pay a Mr Delboe £ 400.

Start of paper money

1690 - The Massachusetts Bay Colony issued the first paper money in the colonies which would later form the United States.

1848 Bank of France is given a nationwide monopoly of note issues

The national bank is given a monopoly of note issuing to fill the gap left by the failure of numerous local banks. The Bank of France also begins to develop a large network of branches in different parts of the country.

was initially a claim on gold

has no natural (intrinsic value), hence acceptance is backed by guarantees from a central authority

Cont….Cont….

Paper currency was introduced as a Paper currency was introduced as a mode of payment.mode of payment.

Originated as a receipt issued by Originated as a receipt issued by Goldsmiths.Goldsmiths.

These receipts were then later on used These receipts were then later on used for payments.for payments.

Cont….Cont….

PAPER MONEYPAPER MONEY Refers to the Notes issued by the State Refers to the Notes issued by the State

or by the Bank, usually the Central or by the Bank, usually the Central bank.bank.

CREDIT MONEYCREDIT MONEY

Includes Bank money (different Includes Bank money (different instruments offered by the Banks.instruments offered by the Banks.

Cheques, Demand Drafts, are examples.Cheques, Demand Drafts, are examples.Convenient, Safe and easily convertible Convenient, Safe and easily convertible

into cash.into cash.

Near Money

The assts which can be easily and quickly transferred into money without loss in value.

Cannot be used directly for making payment and is to be converted in to proper money as and when needed for spending.

Near Money or non-monetary liquid assets mainly consist of time deposit, treasury bills, government securities, Bills of Exchange.

What is Money

Imagine today’s world without money, how do you find it?

Don’t you think the ‘Money’ is the greatest invention of mankind?

Definitions: Descriptive. Legal. General acceptability.

Descriptive Definitions:

Mainly focus on the functions of money and not what the money is. “Anything that is generally acceptable as a

means of exchange and that at the same time acts as a measure and store of value”. Crowther, An Outline of Money.

“Money may be define as a mean valuation and Payment”.

“Money is anything that is widely used as mean of Payments and is generally acceptable in settlement of debts”.

Legal Definitions

Based on “The state theory of money”. “Anything which is declared by the state

as money is money”. Professor Knap Professor Hartley believes that money

should be legal tender. It should be declared by the government of a country as a mean of payment and people should be forced to accept it for purpose of money.

General Definition

1. Money is anything which is commonly used and generally accepted as a medium of exchange or as standard of value. Kent

2. “Doctor Robertson has described money, “as anything which is widely accepted in payment for goods or in discharge of other kinds of business obligations.

3. Money is anything that is generally accepted in payment for goods and services or in the repayment of debts. S. Mishkin

Functions of money:

Functions of moneyFunctions of moneyFunctions of moneyFunctions of money

ContingentContingent

functionfunctionPrimary function

Secondaryfunction

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The primary functions of money are;

Primary Functions

Medium of exchange

Unit of account

Standard of deferred payments

Store of values44

Primary Functions

1. Money as a medium of exchange: Money acts as a medium of exchange and

helps in overcoming the difficulty in barter economy.

In all market transactions, money is used to pay for goods and services i.e. the sale or purchase of goods is done through money.

2. Money as a unit of account: Money serves as a common measure of value

i.e. the value of goods and services can be expressed in terms of unit of money.

Cont….

3. Money as a standard of deferred payments: Money is used to make payments in the future

time. Money is the only unit of account which is easy

to borrow and easy to lend.

4. Money as a store of value: Money also functions as a store of value. Money is the most liquid of all assets,

therefore it is, easier to store value (resources) in the form of money.

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The secondary functions of money are;

Secondary Functions

Aid to production

Money facilitatesto FOP

Money as a tool of monetary management

Money as a instrument of making loan

44

Secondary Functions

1. Aid to production and trade: The market mechanism, production of

commodities and expansion of trade etc. have all been facilitated by the use of money.

2. Money specialization to FOP: All production takes place for the market and

the factors payments (rent, wages, interest and profits) are made in money.

Cont….

3. Money as a tool of monetary management:

All the monetary progress is done due to money. Economic policy for achieving growth, reduce unemployment, favorable balance of payment only can be achieved through money

4. Money is an instruments of making loans: People save money and deposit it in the

banks. The banks advance these savings to businessmen and industrialists.

Thus money is the instruments by which savings are transferred into investments.

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The contingent functions of money are;

Contingent Functions

Distribution of National income

Basis of credit

Liquidity of property

Contingent Functions

Distribution of National income: Money facilitates the distribution of

national income among the various productive and non-productive purpose. In the modern world  people join together to run a business organization. Many people contribute their money, efforts, skills and space etc.  When that business organization make profits, it should be divided as per the proportion of efforts or skills or money put in by all those who are involved.

Basis of credit system:

The present day money (Coins, currency notes, cheques, bank drafts etc) is a promise to pay. 

The modern economy is based on promise to pay.

Banks create credit on the basis of their cash reserves. So money can serve as a basis of credit system. 

Cont….

3. Liquidity of property: Money is convenient form for holding the

wealth.  As money can buy any asset at any time.  As well as any assets can be converted in to money.  So money is the most liquid form of asset.

Money gives a liquid form to wealth. A property can be converted into liquid form with the use of money.

CHARACTERISTICS GOOd OF MONEYCHARACTERISTICS GOOd OF MONEY

General Acceptability.General Acceptability.Stability of Value.Stability of Value.Transportability.Transportability.Storability.Storability.Divisibility.Divisibility.Homogeneity.Homogeneity.