Friday, April 1, 2011

Money - An Economic Overview

Evolution of Money: The fundamental aim of man is to satisfy his economic wants. In earlier days man produced whatever was needed by him. But in course of time, economic wants started to increase. So to satisfy all his economic wants, man started to exchange the goods. In earlier days the system that was followed for exchange is known as the Barter System. Under this system there was direct exchange of goods for goods. But man started to face many difficulties under this system. So to overcome these difficulties man introduced money.

First precious metals were used as money. Then, in course of time, a small quantity of a metal, with a with a stamp or mark put on it to indicate value, was introduced to serve the purpose of money. This process is called coinage. Now a days paper money, duly sanctioned by law, with appropriate signs and symbols, is used used universally as the medium of exchange. For small transactions, however, coins are still used.

Legal Tender Money: Legal tender money means money, the tender or payment of which constitutes, by law, the sufficient discharge of a debt.

The fundamental difference between money and other commodities is that money is generally acceptable in payment for goods, services, debts and compensations, while other commodities are not. People want other commodities for the commodity's sake - to consume, enjoy or otherwise utilize them, but money is wanted not for its own sake but because it has purchasing power over other goods.

The real significance of money is that it is a claim, which can be used by its owner to buy everything. As because general acceptability is the fundamental characteristic of money, we can define money as anything which is generally accepted by people in exchange for commodities or services, or in payment of debts or compensations.

Mr. Paul Samuelson: "Money is an artificial social convention."

Definition: Money is something, which serves as a medium of exchange. It is accepted unquestionably by everyone in exchange for goods and services. Different economists have defined money in different ways. According to Mr. Francis Walker "money is what money does."

We can define money as anything, which is accepted by the people

1. as medium of exchange,
2. as a measurement of value,
3. as a store of value,
4. as a standard of deferred value, and
5. as a transfer of value.

From this above definition follows the functions of money.

1. Medium of Exchange: Money promotes or facilitates exchange of goods and services. Our whole economic system depends entirely upon money, without which all modern forms of consumption, production, distribution and exchange will cease to exist.

2. Measurement of Value: Money assigns a value or price to any commodity or service. Every commodity or service can be weighed in terms of money. So it serves as a measuring instrument for value.

3. Store of Value: Money is the best form in which one can store his wealth. It has a universal usefulness at any given time, which makes it the best form as a store of value.

4. Standard of Deferred Value: Money serves as standard for deferred payments, that is payments, which are to be made in future.

5. Transfer of Value: Since any economic commodity or service can be weighed in terms of money, for any kind of value transfer it acts as the best medium.

Demand for money or reasons for holding money: J, M. Keynes forwarded three primary reasons or motives for holding money.

1. Transactions motive: Every man requires a certain amount of money to meet his daily expenditure. From this, the transaction demand for money arises.
2. Precautionary motive: People normally hold more money than what is required for his transactions purpose. He keeps some extra money in hand to meet the unforeseen circumstances, or any kind of emergency situation. This gives birth to the precautionary demand for money.
3. Speculative motive: Money, when invested, brings income in the form of interest. If someone decides to hold money he will be foregoing the interest that it would have yielded, if invested. Thus holding money means preferring liquidity, as money is the most liquid form of asset. When there is an expectation that interest will rise in the future, people purchase securities to earn higher interest income in the future. Interest is the reward for parting with liquidity. Thus individuals or institutions, who have sufficient money left after satisfying the first two demands, may also need some money for speculative purpose.

In the short run, transactions demand and precautionary demand are more or less fixed. Only under a situation of rising prices and consequent inflation, these two demands may increase in the short run. Otherwise in the short run, it is the speculatory demand for money, which determines the overall demand for money.

Supply of Money: The supply of money basically means the quantity of money in circulation. In simple terms, the total amount of cash held by individuals and institutions in the form of notes and coins, together with the total value of deposits held in bank accounts of commercial banks, together with bills and bank notes constitute the supply of money. Some writers prefer to use the term money in a narrow sense to mean only legal tender money. Others include deposits, but only such deposits as are withdrawable by cheques, thus excluding non-chequeable deposits. The measures that are taken to control the total supply of money in an economy are compositely called the Monetary Policy.

Value of money: Meaning: Value of money means the purchasing power of money. It means that goods and services can be purchased with money. When more goods and services can be purchased with money, the value of money is said to be more, and vice versa.

Determination of the value of money: There are two theories given by the economists for the determination of the value of money. The two theories are

1) Quantity Theory of Money
2) Income Theory of Money

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