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PRIMARY FUNCTIONS OF MONEY .

Money as a Medium of Exchange: The function of money as a medium of exchange solves all the difficulties of barter system. There is no necessity for a double coincidence of wants in the money economy. The man with cow who wants to purchase cloth need not seek a cloth seller who wants a cow. He can sell his cow in the market for money and then purchase cloth with the money obtained. 2. Money as Measure of Value: In money economy values of all commodities are expressed in terms of money. Money is like the yard stick of cloth merchant, as yard-stick measures all varieties of cloth, money measures the value of all varieties goods. This function of money makes transactions easy and also fair 3. Standard of Deferred Payment: In a money economy the contracts are made for future payments terms of money instead of goods and promise to repay the loan in money. In this way money is the standard of deferred payments. This function stimulates all kinds of economic activities wjtich depend on borrowed money. 4. Money as a Store of Value: Goods cannot be stored because they are perishable. People receive their incomes in money form and keep their savings in money form in banks.In this way, money is used to store value of commodities. 5. The essential or primary functions of money are: a) To serve as medium of exchange. b) To serve as a measure of value. The later two functions are of secondary importance because they; derived functions. In modern economy, money plays a very important role. Its disappearance would cause disappearance of the economy itself. Medium of Exchange THE primary function of money is to act as THE medium of exchange. People use money to buy and sell goods. Buyers give up money and receive goods.

Sellers give up goods and receive money. Money makes transactions easier because everyone is willing to trade money for goods and goods for money. To see why money makes transactions easier, consider a barter economy that has no money, where one good is traded directly for another. The key to successful barter trades is double coincidence of wants, each trader has want the other wants and wants what the other has. Without double coincidence of wants, a barter economy can become exceedingly inefficiency. Traders spend more time seeking trades and less time producing goods. Suppose, for example, that Duncan Thurly heads into town with a basket full of hand-crafted hamster hats (not hats made FROM hamsters, but hats made FOR hamsters) which he hopes to trade for a pair of knickers--what others might call pants. If the local knicker-maker (Kevin) needs hamster hats, the there is a double coincidence of wants and they are ripe for a trade. However, if Kevin the tailor has no desire to acquire hamster hats, then there is NOT a double coincidence of wants and Duncan does NOT get his knickers. At least he will not get his knickers without spending some time, perhaps a great deal of time, seeking to trade his hamster hats to someone else for a good that the tailor does desire. Duncan might need to seek out dozens of other people, conducting dozens of intermediate trades, before he finally has a good that can be traded for knickers. The time he spends on barter trades is time that he CANNOT spend fabricating additional hamster hats, to the loss of hamster owners worldwide. Money eliminates the need for double coincidence of wants because EVERYONE is willing to accept money in payment for goods. Duncan can trade his hamster hats for money (that is, sell), trade this money for the knickers (that is, buy), then returned home for further hamster-hat fabrication. With a generally accepted medium of exchange, trades are easier, more efficient, and resources can spend more time doing production. Unit of Account The second function means that is money is being used as the common benchmark to designate the prices of goods throughout the economy. Unit of account, or measure of value, means money is functioning as the measuring

unit for prices. In other words, prices of goods are stated in terms of the monetary unit. If Duncan Thurly is heading off to the market in search of hamster hats or tailored knickers, then he will find each has a price in terms of the medium of exchange. If his society make use of U.S. dollars, then hamster hats carry a U.S. dollar price. If he lives in a land that uses German marks, then knicker prices are in terms of marks--German marks. The reason is that sellers are willing to trade for, and buyers are willing to give up, THE medium of exchange--money. That is why money is THE medium of exchange. It is used for exchanges. Using money as the unit of account for prices, however, also provides a measure of value--how much value buyers and sellers place on a good. If tailored knickers carry a $10 price, while hamster hats go for $5 each, then this indicates a measure of the relative value of each commodity--knickers have twice the value of hamster hats. Buyers are willing to give up twice as much money to buy a pair of knickers as to acquire a hamster hat and sellers incur twice the opportunity cost of producing a pair of knickers as that of hamster-hat production. Store of Value The third function, store of value, emerges because money is one way of postponing the satisfaction obtained from using or consuming goods until a later time. Value is obtained from a good when it is consumed, when it is used to satisfy wants and needs. The value from consuming goods can be stored in several different ways, one of the best is money. Consider a few ways that Duncan Thurly might be able to store the value of a $2 hot fudge sundae for one week. First, he could buy a freshly fabricated hot fudge sundae for $2 and store this product for seven days. Successful storage requires a freezer, especially during the summer. Would this hot fudge sundae retain its full $2 value one week hence? Probably not. The hot fudge is likely to be cold. The whipped topping is probably unwhipped.

Second, Duncan could purchase a $2 gift certificate from the ice cream parlor, a coupon that is tradeable for one hot fudge sundae. After a week, he can redeem the certificate and enjoy his treat. In this case the value of the sundae is stored in the coupon. While this is a relatively good store of value for the hot fudge sundae, it ONLY stores the value of a hot fudge sundae. A hot fudge sundae coupon cannot be used to store the value of other goods. Third, he could take his $2, use it to purchase another good, like a book, hold onto it for a week, sell it, then use the proceeds to buy a hot fudge sundae. Of course, if the book is not very liquid, meaning that it cannot be easily converted into money, then he probably will not end up with the $2 that he needs to buy his hot fudge sundae. Storing the value of one good by purchasing then later selling another good is seldom the best way to go. Fourth, Duncan could simply keep $2 stashed away in his billfold, sock drawer, or coffee can buried in his back yard. After one week, he can then amble down to the ice cream parlor with this $2 in hand to make his hot fudge sundae purchase. In this case, he has stored the delicious value of the hot fudge sundae in the form of money. The problem with storing value in money is price changes. If the price of the hot fudge sundae rises during this week, then Duncan's money becomes a less effective means of storing value. As a general rule, price inflation is the nemesis for the store of value function of money. Standard of Deferred Payment This fourth function means money is used as a standard benchmark for specifying future payments for current purchases, that is, buying now and paying later. This function may seem obscure, but it is a direct result of the store of value and unit of account functions. A common example of deferred payments is a car loan. Duncan Thurly get a loan to buy a car today, then pay off the loan with payments deferred into the future. The amount of those future payments are stated in terms of money. Using money as a standard of these deferred payments is a direct consequence of the unit of account and store of value functions of money. If money is the standard for current prices, then money is also the standard

for future payments based on those prices. But, for money to function as a DEFERRED payment standard, it must retain value, it must store value. The key to storing value in money is price inflation. This means that deferred payments need to anticipate future money values based on future inflation. If inflation is, for example, 10 percent next year, then deferred payments need to be adjusted for the resulting decline in money value. This inflation adjustment is accomplished by through interest rates.

There are two primary function of Money they are: 1. Medium of exchange 2. Measure of value.

Primary functions of Money


Money as a Medium of Exchange: The function of money as a common medium of exchange facilitate the activity of buying and selling of goods and services. This function effectively solve the problems of a barter system. It is the most important and unique function of money which separates it from near-money assets. Money splits exchange into two parts. Sale and Purchase. Money as a measure of value: Money act as a instrument for measuring goods and services in terms of their money value. In the absence of money, it would be tedious to measure the value of goods and services for the purpose of exchange. Thousands of goods are available in the market. You can imagine how difficult it is to exchange these goods if there is no common medium to value these goods and services. One person who is offering his product to different people should keep thousands of values for his one product to effectively do his business. Money removes this problem by acting as a common medium. Due to the introduction of money, a trader should keep only one value for his each goods and services. Also it is to be noted that different goods are measured in different physical units like Litter, Kilogram, meter etc. Comparison of value of goods which has different physical units also possible if you know the money value of each goods. Comparison of goods in different region or time is possible through knowing the money value of the goods. The use of money price also help us in estimating national income by adding up values of a wide variety of goods and services which are measured in different physical units.

Money as a measure of value can serve satisfactorily only when its own value (i.e. purchasing power) remains stable over time. Continuous rise in general level of prices all over the world has made money a poor measure of value.

Secondary Functions of Money


Secondary functions are: 1. Money as a standard of deferred payments 2. Money as a store of value 3. Money as a means of transferring purchasing power Let us looking into it in detail Money as a standard of deferred payments: Money facilitates not only the current transactions of goods and services but also their credit transactions. It facilitates credit transactions when goods are exchanged against future payments. Now a days deferred payment is become our part of our life as loan installments, pension, insurance premium etc are paid as deferred payments. Money could be an effective standard of deferred payment. For that purpose the value of money should be stable. If prices increase or decrease sharply, resulting in large fluctuations in the value of money, it would make money a poor standard of deferred payments. Money as a store of Value: We can store or hold a part of our present earnings in the form of money to be spent in future. Money represents generalized purchasing power and is a perfectly liquid asst as well. It is stable in value and useful in purchasing goods and services to satisfy human wants in a future time. Also we can store it for a longer period and need less space than other goods. So it is convenient to accumulate wealth in the form of money which can be converted in to any asset at any time. Money serve as a bridge from the present to the future as money saved today can shift our purchasing power from the present to the future. Money as a means of transferring purchasing power: Money is the most convenient form in which value can be transferred from one person to another and also one place to another. The reason is that it is light weight, high value and less space consuming as compared to other goods. Also everyone readily accept money irrespective of place. For example, transferring thousands of kilograms of food grains would be time consuming, expensive and incur a lot of efforts and wastage. On the other hand transferring value of that much food grain in the form or money is less expensive and easy by a cheque or a bank draft. So money act as a means of transferring purchasing power.

Contingent Functions of Money


Contingent Functions

1. Distribution of National Income 2. Basis of credit system 3. Maximization of utility and profits 4. Money imparts liquidity and uniformity to assets Distribution of National Income: 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. Money helps in the distribution of national income among the people who have contributed in its production. This income is divided or distributed in the form of rent, wages, salary, interest, renumeration etc. It is very difficult to determine and and remunerate those who contributed machine, property or materials. This problem can be easily overcome by determining the money value of such properties and distribute income proportionate to their contribution. So money helps in the distribution of national output among the people. 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. One of the area of function of bank is to receive money from depositors and lend it to those who are in need for running business or purchasing goods. Banks charge a fixed or variable rate of interest for their service. Depositors also get a portion of interest for their deposits. So money can serve as a basis of credit system. Maximization of utility and profits: If a farmer who does farming make one or two types of crops in bulk quantity. If he sell it for cash, he can use that money for satisfying his many of the needs. Keeping food grains limits his utility. On the other hand when he turns it into cash i.e. money, his scope of utility increase. Likewise producers of goods can calculate the cost of production in the value of money and decide a selling price which is profitable. In this way they can maximize their profits. So another use of money is that maximization of utility as well as profits. Money imparts liquidity and uniformity to assets: 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. Another function of money is it can calculate the wealth of the person by calculating the value of his property and things that are in his possession in the form of money value. Total wealth of a person or a country can be ascertained by calculating the money value of all assets. So the another function of money is that it imparts liquidity and uniformity to assets.

What are the important functions of Money ?


APARIJITA SINHA

Various functions of money can be classified into three broad groups: (a) Primary functions, which include the medium of exchange and the measure of value; (b) Secondary junctions which include standard of deferred payments, store of value and transfer of value; and (c) Contingent functions which include distribution of national income, maximization of satisfaction, basis of credit system, etc. These functions have been explained below:

1. Medium of Exchange:
The most important function of money is to serve as a medium of exchange or as a means of payment. To be a successful medium of exchange, money must be commonly accepted by people in exchange for goods and services. While functioning as a medium of exchange, money benefits the society in a number of ways: (a) It overcomes the inconvenience of baiter system (i.e., the need for double coincidence of wants) by splitting the act of barter into two acts of exchange, i.e., sales and purchases through money. (b) It promotes transactional efficiency in exchange by facilitating the multiple exchange of goods and services with minimum effort and time, (c) It promotes allocation efficiency by facilitating specialization in production and trade, (d) It allows freedom of choice in the sense that a person can use his money to buy the things he wants most, from the people who offer the best bargain and at a time he considers the most advantageous.

2. Measure of Value:
Money serves as a common measure of value in terms of which the value of all goods and services is measured and expressed. By acting as a common denominator or numeraire, money has provided a language of economic communication. It has made transactions easy and simplified the problem of measuring and comparing the prices of goods and services in the market. Prices are but values expressed in terms of money. Money also acts as a unit of account. As a unit of account, it helps in developing an efficient accounting system because the values of a variety of goods and services which are physically measured in different units (e.g, quintals, metres, litres, etc.) can be added up. This makes possible the comparisons of various kinds, both over time and across regions. It provides a basis for keeping accounts, estimating national income, cost of a project, sale proceeds, profit and loss of a firm, etc. To be satisfactory measure of value, the monetary units must be invariable. In other words, it must maintain a stable value. A fluctuating monetary unit creates a number of socioeconomic problems. Normally, the value of money, i.e., its purchasing power, does not remain constant; it rises during periods of falling prices and falls during periods of rising prices.

3. Standard of Deferred Payments:


When money is generally accepted as a medium of exchange and a unit of value, it naturally becomes the unit in terms of which deferred or future payments are stated. Thus, money not only helps current transactions though functions as a medium of exchange, but facilitates credit transaction (i.e., exchanging present goods on credit) through its function as a standard of deferred payments. But, to become a satisfactory standard of deferred payments, money must maintain a constant value through time ; if its value increases through time (i.e., during the period of falling price level), it will benefit the creditors at the cost of debtors; if its value falls (i.e., during the period of rising price level), it will benefit the debtors at the cost of creditors.

4. Store of Value:
Money, being a unit of value and a generally acceptable means of payment, provides a liquid store of value because it is so easy to spend and so easy to store. By acting as a store of value, money provides security to the individuals to meet unpredictable emergencies and to pay debts that are fixed in terms of money. It also provides assurance that attractive future buying opportunities can be exploited. Money as a liquid store of value facilitates its possessor to purchase any other asset at any time. It was Keynes who first fully realised the liquid store value of money function and regarded money as a link between the present and the future. This, however, does not mean that money is the most satisfactory liquid store of value. To become a satisfactory store of value, money must have a stable value.

5. Transfer of Value:
Money also functions as a means of transferring value. Through money, value can be easily and quickly transferred from one place to another because money is acceptable everywhere and to all. For example, it is much easier to transfer one lakh rupees through bank draft from person A in Amritsar to person B in Bombay than remitting the same value in commodity terms, say wheat.

6. Distribution of National Income:


Money facilitates the division of national income between people. Total output of the country is jointly produced by a number of people as workers, land owners, capitalists, and entrepreneurs, and, in turn, will have to be distributed among them. Money helps in the distribution of national product through the system of wage, rent, interest and profit.

7. Maximization of Satisfaction:
Money helps consumers and producers to maximize their benefits. A consumer maximizes his satisfaction by equating the prices of each commodity (expressed in terms of money) with its marginal utility. Similarly, a producer maximizes his profit by equating the marginal productivity of a factor unit to its price.

8. Basis of Credit System:


Credit plays an important role in the modern economic system and money constitutes the basis of credit. People deposit their money (saving) in the banks and on the basis of these deposits, the banks create credit.

9. Liquidity to Wealth:
Money imparts liquidity to various forms of wealth. When a person holds wealth in the form of money, he makes it liquid. In fact, all forms of wealth (e.g., land, machinery, stocks, stores, etc.) can be converted into money.

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