Chapter No 1

The Nature And Functions Of Money

 Chapter
overview
• Definition of money
• Money and its functions
• Stages in the development of
money
• Qualities of a good money
• Barter system and barriers of
barter system
• Role of Money
 Mone
y
• A generally accepted medium for the
exchange of goods and services, for
measuring value, or for making payments.
• Many economists consider the amount of
money and growth in the amount of money
in an economy very significant in
determining interest rates, inflation, and the
level of economic activity.
 Functions of
money
• Medium of exchange
• Measure of value
• Future payments
• Budgeting
• Economic activities
• Transfer of wealth
• Store of wealth
• Determination of national
income
• Liquidity of wealth
• Promote to foreign exchange
• Market mechanism
• Basis of credit creation
1.Medium of exchange:
Money acts as a medium of exchange
between the buyer and seller. Money is used
to make
payments for goods and services. Goods can
sold for money and that money can be used
to
purchase goods.
2.Measure of value:
Value of different goods and services can be
measured in Monterey terms, in the same as
we
3.Future payments:
Future payments can be easily determined with
the help of money. One can borrow loans from
banks and other financial institutions in form of
money and repayment can be made as well in
form of money.
4.Budgeting:
Money helps government and companies in
preparation of budgeting. Incomes and
expenses
are estimated and recorded in terms of money.
5.Economic activities:
All type of economic activities such as
investments, savings, credit are made in terms of
money. Money has played a vital role in economic
growth of a society.
6.Transfer of wealth:
With the help of money wealth can be
transferred easily form one place to another
place. One can sold his property at one place
against money and he can buy similar at
some other place
7.Store of wealth:
Wealth can be stored easily in form of
money. One can save his wealth by
converting it in
money.
8.Determination of national income:
With the help of money, it becomes easy to
determine the income generated by a nation.
It also helps in determination of Gross
Domestic Product of a country.
9.Liquidity of wealth:
Liquidity means conversion of property in
form of cash. Wealth or property can be
converted
in liquid from with the help of money.
10.Promote to foreign trade:
Money has played a vital role in the growth of
foreign trade. Foreign investments are made
in
terms of money. Payments and receipts of
other countries are made in terms of money.
11.Market mechanism:
Market mechanism is based on the demand,
supply and price of the goods. Demand and
supply are the two major factors of market
which work only because of money. Money
is the only factor which determines the
price, demand and supply of goods.
12. Basis of credit creation:
Banks create credit on the basis of cash
deposits in banks. So it is not possible for
banks to create credit without the help of
money.
 Stages In The
Evolution Of
Money
On the basis of evolution the money is
classified in five main types
1. Commodity money
2. Metallic money
3. Paper money
4. Credit money
5. Electronic money
 1. Commodity
money
• In commodity money, different
commodities have been used as money .
• Commodity money was used in barter
system in which goods were exchanged with
other goods and services.
 2. Metallic
money
Metallic money consists of gold coins, silver
coins, metal coins. Metallic money cannot be
eliminated from economy. It is playing vital
role in the economy. Metallic money is of
three kinds.
i. Full bodied money
ii. Token money
iii. Tender money
i.Full bodied money
In full bodied money, the metallic value of coin is equal
to their face value. Full bodied money is also called
standard money or natural money. The gold silver and
nickel are considered as full bodied money. Now such
money is not used anywhere in the world.
ii.Token money
In token money the face value of coin is higher than
the metallic value. They are usually made of silver,
copper or nickel. In Pakistan full bodied money does
not exist only token is used.
iii.Tender money
Any currency which is generally acceptable in discharge
of debts is called tender money it can be made of
paper or metal. If someone offers tender money against
debts, nobody can refuse to take it.
3. Paper money
Paper money consists of notes issued by
the state bank of Pakistan. The paper
money is of
different values, colors and sizes. Paper money
is more convenient than any other form of
currency.
4. Bank money
Bank money includes cheques, bills of
exchange, and drafts. Bank money is playing a
vital role in the economic development.
Because varies transactions are settled without
the use of paper money. Bank money is safer
than any other form of money.
5. Electronic money
With the development of computers and
its application, the business and business
transactions are changing very fast. Now a
day’s most of the transactions take place
through electronic money. People prefer to use
debit cards and credit cards instead of paper
money or bank money. With the passage of
time electronic money may diminish the use
of paper
money.
 Qualities Of Good
Money
1. Acceptability
2. Transferability
3. Stability
4. Storability
5. Recognizable
6. Malleability
7. Divisibility
8. Durability
9. Economy
10.Elasticity
11. Homogeneity
1.Acceptability
Good money should have the quality of general
acceptability. General acceptability means every
person must accept it for the settlement of
payments. It should be accepted for purchase
and sale of goods.
2.Transferability
Good money is easily transferable from one place
to another for doing business and making
payments.
3.Stability
Value of money should remain stable. If value of
money is changing or fluctuating day by day than
it would not be considered reliable.
4.Storability
The money should be storable. Value of money
should not depreciate with time. Paper money
has quality of storability.
5.Recognizable
The money should be easily recognizable so that
the holder of money may not confuse about the
value of money. Paper money is easily
recognizable because notes of different value
have different color.
6.Malleability
The material which is used for making money
should be malleable. The material which cannot
be melted is not fit for making coins.
7.Divisibility
Divisibly means ability to divide into small
units without losing its value. Good money
should be divisible. In barter system,
commodity money was not divisible into small
units. That’s why it was replaced by the paper
money.
8.Durability
The material used in making money should be
durable and long lasting. Coins do not wear
quickly, so the quality of money remains
stable.
9.Economical
Good money should be economical.
Economical means low cost of printing and
more value.
10.Elasticity
Supply of money should be elastic. Elastic
means whenever it is needed, supply of money
can be increased or decreased. Paper money
has the quality of elasticity
11.Homogeneity
Homogeneity means the money should be
identical. So that there is no ambiguity to
the holder of money
 Barter
system:
• Barter is a system in which goods or
services are directly exchanged with the
goods or services without the use of
money.
• Barter system is suitable only when people
have few needs and money system does
not exist in the economy.
 Barriers of barter
system:
• Lack of chance of wants
• Lack of common measure of value
• Lack of subdivision
• Lack of store of value
• Difficulty in future payments
(credit)
• Difficulty in transfer of wealth
• Difficulty in tax collection
 Role of
Money
Money plays an important part in the daily
life of a person whether he is a consumer, a
producer, a businessman, an academician, a
politician or an administrator. Besides, it
influences the economy in a number of ways.