MONEY MEANING AND FUNCTIONS

 BARTER SYSTEM OF EXCHANGE

o Exchange is the act of trading the surplus goods people have to obtain the other
things which they require
o Barter system - Goods and services are exchanged directly for other goods and
services.
o Economy based on barter exchange is known as barter economy.
o Limitations-
1. Lack of double coincidence of wants
2. Lack of any common unit to measure the value
3. Exchange of large and indivisible commodities for small quantities of other
commodities.
4. Waste of human effort.

 MEANING OF MONEY
o Functional definition of money- money defined primarily by the use or the purpose
which they serve.
o Crowther- Anything that is generally acceptable as a measure of exchange and
at the same time acts as a measure and store of value.
o Why most suitable definition?
 Emphasize on important function- medium of exchange, measure of value and
store of value.
 Pinpoint basic characteristic - general acceptability.

 KINDS OF MONEY
1. Currency- coins and paper currency
2. Deposit money component

1. Coins
o What is Intrinsic value and Face value?
o Face values of token coins are more than its intrinsic or metallic value.
o Right of minting coins is the Monopoly of the government
o Facilitate transaction of smaller denomination.

Currency notes (paper money)

o Issued by RBI
o Convertible money and inconvertible money
o At present all paper currency is inconvertible.
o People have confidence in it as it is issued on the order (Fiat) of the government.
o Fiat money because legal tender.

2. Deposit money or bank money

o Deposits held with the bank.
o They are payable on demand and can be transferred from one person to another.
o Cheque- an instruction to the bank to make payment or to make transfer equal to the
amount mentioned in the cheque.
o Cheque bearer can get cash after depositing the cheque
o The check itself is not money.
  Coins and currency notes are legal tender (legal sanction or backing of the
government)
 Cheque are not legal tender. A person can refuse to take the payment in the form of
a cheque deposit.
 What is limited and unlimited legal tender?

 FUNCTIONS OF MONEY
1. Primary functions
(i) Medium of exchange- Replaces barter system → removes double
coincidence of wants.
o Accepted widely → increases efficiency in trade.
(ii) Measure of value- Price = value of a commodity expressed in money terms.
o All goods/services expressed in terms of rupees → makes comparison easy.

2. Secondary function
(i) Standard of deferred payments-extension of medium of exchange function
o Money is accepted with confidence in present and in future both because it will
have value in future as well.
o A particular kind of good might not have value in the future.
o A standard measure of unit exists in money.
(ii) Store of value - most economical and convenient way of storing wealth.
o Bond shares etc compete with money
o Better store of value- perfectly liquid asset.
(iii) Transfer of value- most convenient mode of transfer of value.
o A house in Delhi can be converted into money and that money can be used to buy
a house in Kolkata. The value of a house in Delhi is now converted into the value
of a house in Kolkata.

3. Contingent function
(i) Maximization of utility - MU=P
(ii) Employment of factor inputs - producers equate value of output produced with
factor price (wage) using money.
(iii) Distribution of national income -National income is the combined income of all
factors of production (land, labour, capital, entrepreneur).
o The contribution of these factors of production is calculated in terms of money as
factor income (wages, rent, interest and profit)
(iv) Basis of credit system- Modern economies run on credit (buy now, pay later
system).
o Credit (like cheques, credit cards, loans) is possible only because money exists.
o All credit instruments are basically promises to pay money in the future.

 IMPORTANCE OF MONEY
1. To consumer - seller of the factor services, purchasing goods and services,
maximize their total satisfaction, savings.
2. In production - Prices of goods/services give signals about demand, based
on which production decision is taken. Factor prices enable the producer to
take decision about the fact of combination to maximize their profit.
3. In distribution - National income is distributed among factors of production
as factor payment, which is calculated in terms of money.
4. In trade- replaced barter → simplifies exchange.
Promotes national & international trade.
 5. In capital formation- process of creating and adding new capital
assets→ investment→credit→savings in bank → money.
6. In public finance- government revenue & expenditure.
Taxes, fees, fines, duties → collected in money.

 SUPPLY OF MONEY
1. Money supply is the money in circulation.
 Money held by Central Bank commercial bank or government are not money
supply
 Money held by economic units like private individuals, business firms,etc will be
included.
2. Stock concept- measured at a point of time.

 COMPONENTS OF MONEY SUPPLY

1. Currency
o coins- issued by the central government
o Paper notes- issued by RBI
o 1 rupee note- issued by central government.

2. Deposit money (bank money)

o Demand deposit held by the public with commercial bank.
o Can be withdrawn using cheque
o Not a legal tender.

 MEASURE OF MONEY SUPPLY;

o What is narrow and broader concept of money?
o 4 measures of money supply in terms of different degree of liquidity

M1 M2
Most liquid
1. Currency held by public (C) 1. M1
(Narrow Money) 2. Demand deposit of the public with 2. Saving deposit with post
the commercial banks (DD)
office saving banks (SD)
3. Other deposits with RBI.(OD)
M3 M4
Less liquid
1. M1 1. M3
(Broad Money) 2. Time deposits with commercial 2. Total deposits with the post
banks (TD) office savings organization
excluding National Savings
certificates (TDP)

1) M1- Currency held by public (C) + demand deposit of the public with the
commercial banks (DD)+ other deposits with RBI (OD)
C- Notes or coins, people keep with themselves
DD- Money in their bank account, withdrawn anytime on demand
OD- These are deposits kept with RBI by special institutions (not by the public).

2) M2- M1+ saving deposit with post office saving bank (SD)
 SD- Money kept in post office saving account which earns interest. Less
liquid.

3) M3- M1 + Time deposits with commercial banks (TD)

TD- Money kept for a fixed. And can’t be withdrawn before maturity without penalty

4) M4- M3 + Total deposits with the post office savings organization excluding
National Savings certificates (TDP)
TDP- all the money people keep in post office saving schemes (like savings
accounts, fixed deposits, recurring deposits, monthly income schemes) but not
National Savings Certificates (NSC).

 HIGH POWERED MONEY

● Also known as monetary base
● The central bank money
● Includes
1. Currency (money in circulation)
2. Deposit held by the bank as reserve with Central Bank
3. Other deposits with RBI - any deposit kept in RBI other than commercial banks like
foreign institutions, state government, foreign country etc.
● Currency deposits of the commercial bank with RBI and other deposits with RBI multiply
the money by giving loan etc.
● Acts as a seed. Multiplies money.

 INFLATION
Inflation is a persistent and appreciable rise in the general price level of goods and services
in an economy.
Features:
 Refers to increase in overall/average price level, not just price of one or two goods.
 Must be continuous/persistent, not a one-time rise.
 Must be a considerable rise (mild rise of 2–3% per year is not considered inflation).
 Expressed as Inflation Rate = % increase in overall price level year to year.
 Demand-Pull Inflation- Inflation that arises due to increase in aggregate demand in
the economy.
 Reasons
o Increase in consumer expenditure.
o Increase in investment.
o Increase in government expenditure.
o Increase in exports.
 Excess demand pulls up prices → results in inflation.

 Cost-Push Inflation- Inflation caused by increase in cost of production (supply side

factors).
 causes:
o Wage-push inflation: rise in wages → higher production costs → higher
prices.
o Profit-push inflation: monopolies/oligopolies increasing profit margins.
o Supply shock: sudden rise in cost of key inputs (e.g., oil price hike).
 Higher costs are passed on to consumers → general price rise.