Money
Definition
Money is some thing, which has general acceptability in the settlement of debt, or in transfer of ownership of goods and services in a country. The value of exchange of every thing in a country is expressed in terms of money.
Mr. Robertson defines money in the following words
“Money is a commodity which is widely accepted in payment of goods or in discharge of other kinds of business obligation”.
An English economist Mr. Hawtrey observes that
“Money is one of those concepts which are definable primarily by the use or the purpose which they serve”.
In the words of Goh Cole,
“Money is purchasing power some thing that buys things”
According to Ely,
“Any thing that passes freely from hand to hand as a medium of exchange and is generally received in final discharge of debts”.
One of the simplest definitions of money is given by Mr. Walker who says that
“Money is what money does”.
In the light of the above definitions, it can be said that
“Any thing that is generally accepted as a means of exchange and at the same time acts as a measures and a store of value”.
Functions of Money
Money is said to perform the following functions
1. It serves as a medium of exchange.
2. It is used as a store of value.
3. It acts as an instrument of deferred payment.
4. It is a measure of value.
These are further discussed below
1. Medium of Exchange
The most general function of money is that it serves as a medium of exchange. The ownership in goods and services is exchanged through it. Money is accepted in exchange of goods and services and property rights simply because in its turn money can be exchanged for them at such places and times the possessor wishes. It means any thing can be brought and sold through it. Money acquires the capacity of serving as a medium of exchange also because of legal sanctions behind it and as such it is generally accepted in the settlements of debts or any financial transaction.
2. Measure of value
Money is used as a measure of value in the sense that the value of every thing is demanded in terms of money. As a measure of value money not only facilitates business transactions but is also useful transacting the sale and purchase if immovable properties buying at distant places. Money as a measure of value is also helpful in asserting the financial worth or stability of a business unit or an industrial concern which is possible from the study of their balance sheets containing the value of their assets and liabilities in terms of money. In simple words we can say that function of money as a measure of value helps us almost in every aspect of our daily life.
3. Store of Value
Another function of money is that it serves as a store of value. We can keep our assets in liquid form so that they can be used any time we feel of doing so. A unique feature of our daily life is that the flow of income does not correspond with the expenditure. The income in the majority of cases does not come to us with the same intervals as we have to make payments and consequently their adjustment would have been difficult but money, serving as a store of value makes a happy adjustment possible between the flow of income and expenditure intervals. Due to its value payments for the future can be made.
4. Instrument of Deferred Payment
Money also acts as an instrument of differed payment, which means that transactions requiring deferred payment are made possible through it. It so happens because the value of money having legal sanction behind, is more stable in comparison to other goods the value of which are liable to great fluctuation under the influence of their demand and supply position. The value of money being stable the parties in transaction are assured of getting the same value even after some time if the payments are made in terms of money. It means that money serving as an instrument of deferred payment facilitates credit transactions. Similarly for the same it encourages lending and borrowing which stimulate saving and investment and ultimately accelerates the economic growth of a country.
5. Transfer of Value
Money has simplified the process of transfer of value from one place to another with out losing its worth. Money is readily accepted by all without any difficulty. It is even possible to transfer a billion of rupees from one place to another.
Types of Money
Generally the classification of money is based on the material that is being used for the purpose. According to the material used, the money can be classified as:
1. Metallic Money
The currency in use or to be used when is made of some metal; it is known as metallic money. The metallic money usually consist of coins made up of gold, silver, copper, bronze etc. a characteristic of these coins is that they are properly shaped and stamped by the central issuing authority to prevent any misuse. In today’s modern age of business the coins are Marley used and issued. The metallic money is further classified as:
Classification of Metallic Money
Full Bodied Coin
Full bodied coin is the one, the face value of which is equal to the quantity of metal used in it. In this case the face value of the coins is equal to its intrinsic value.
Token Coins
A token coin or money is the one whose face value is higher than the value of the metal contained in it. It is usually as a subsidiary unit or coin. In token coin the face value is higher than the intrinsic value.
2. Paper Money
Paper currency refers to the currency notes issued or used in a country. These notes are made up of special kind of paper. Paper currency also includes notes (promissory) and cheques but they circulate as money only in the countries where they are used freely for settling business transactions such as U.S.A and U.K.
In early times when notes were introduced they were backed by an exactly equal amount in gold or silver kept by the issuing authority. Paper money is not wholly backed by some precious metal now. only a proportionate reserves are maintained and a good deal of the paper money rests on people’s of people’s confidence in the word of issuing authority generally the government or the central bank. Such a currency is also called fiduciary issue.
Classification of Paper Money
Paper money may be of following types
(i) Representative Paper Money
When the paper money is backed by an exactly equal amount of in gold or silver kept in reserve by the issuing authority it is known as representative money. Such notes could be exchanged for coins when needed and did nothing more then to represent coins.
(ii) Convertible Paper Money
The currency notes which can be exchanged for full bodied or standard coins is called convertible money. Its value is backed by a proportionate reserve of some precious metal and the confidence in the word of eh issuing authority. It is also called fiduciary money.
(iii) Inconvertible Paper Money
The currency notes that cannot be converted in full-bodied coins. The issuing authority gives no promise for its conversion. It can also be called fiat money.
Advantages of Paper Money
Following are some advantages of the paper money
1. Economical
Currency notes are cheapest media of exchange. Paper money practically costs nothing to the government. It does not need to spend anything on the purchase of gold for minting coins. Certain other expenditure or losses associated with metallic coins are also avoided.
2. Convenient
Paper money is the most convenient mean of money. A large amount can be carried conveniently in the pocket with out any body knowing about it. It possessed in very large measure the quality of portability, which a money material should have.
3. Homogenous
Among the coins there are good and bad coins. But currency notes are all exactly similar. It is therefore the substitute medium of exchange.
4. Stability
The value of money can be kept stable by properly regulating its issue. Managed proper currency method is therefore adopted by many countries.
5. Cheap Remittance
Money in the form of currency notes can be cheaply remitted from one place to another in an insured cover.
6. Elasticity
Paper money is absolutely elastic. Its quantity can be increased or decreased at the will of the currency authority. Thus paper money can better meet the requirements of trade and industry.
7. Advantages to the Banks
Paper money is of great advantage to the banks. They can keep their cash reserves against liabilities in this form, for currency notes are full legal tender.
Disadvantages of Paper Money
Its disadvantages are as follows
1. No Value outside the Country
Paper money is of no value outside the country where it is issued. Gold and silver coins were accepted even by foreigners as they had no intrinsic value.
2. Risk of Damage
There is always a possibility of damage to the paper. Fire may burn it, water may tear it etc.
3. Danger of Over Issue
A serious drawback in paper currency is the ease with which it can be issued. There is always a danger of it’s over issue when the government is in financial difficulties. Once this course is adapted the momentum leads to further notes printing until it losses all the value. This over issue of notes is called over inflation.
4. Price Increase
Some times especially when the money loses its value there is always an increase in the price of goods. As a result, labours and other people with fixed income suffer greatly. The whole public feels the pinch.
5. Effect on Business
During the days of monetary stringencies in a monetary economy, the business activities are affected very badly. The indirect result of price increase, shortage of currency etc, result in a fall of exports and a rise in imports. It leads to the export of gold from the country, which is not a desirable thing. Its balance of payments gets unfavorable.
3. Bank or Credit Money
Bank money consist of demand deposit, which is drawn by cheques. A deposit is like any other medium of exchange and being payable, on demand; serves as a standard of value or unit of an account as it is convertible into standard of value i.e. money or crash at fixed terms. In the words of J.M. Keynes.
"Bank money is simply an acknowledgment of a private debt expressed in the money of account which is used by passing from one hand to another as an alternative of money to settle transactions."
Value of Money
The value of money refers to the purchasing power of one unit of money in terms of goods and services. It indicates the quantity of goods and services that can be had in exchange of one unit of money. If the value of money is studied in relation to the home market, it is called internal value as against external value, which gives the value of money in terms of foreign currency.
Value of Money and Price Level
The price level of a country refers to the value of goods and services in terms of money. It means that value of money is expressed in terms of money. As for example, one unit of money supposes fetches 3 seers of wheat and value of 3 seers of wheat is one unit of money. Suppose the value of money rises and its one unit now fetches 5 seers of wheat. It means that the value of wheat has come down and now 5 seers of wheat will fetch one unit of money, which previously only did 3 seers.
From the above example it is evident that value of money is followed by the fall in price level and vice versa. In other words rise in price level makes the value of money fall and the same quantity of money can be had with more units of money. The above fact can also be interpreted as an increase in the quantity of money brings a corresponding fall in the value of money and the fluctuations in the value of money occurs due to a change in the quantity of money. This relationship between value of money and its quantity is explained by quantity theory of money.
Quantity Theory of Money
Theory
The quantity of money states that other things remaining the same, the value of money falls in proportion to increase in the quantity of money in circulation. It mans that in the case, when the quantity of money increases by 25%, the value of money falls by 25%. Thus the quantity of money and its value of money are inversely related.
Explanation
The value of money like any other commodity is determined by its demand and supply. Thus the quantity theory of money can be explained under these two heads.
1. As Regards Demand of Money
Demand of money according to Fisher is the derived demand i.e. not for direct consumption. Money being a medium of exchange is demanded for the purchasing of goods and services. Demand for money therefore depends upon the demand for goods and services.
2. As Regards Supply of Money
According to Fisher supply of money is represented by the total expenditure made by the people calculated during a given period of time. The total expenditure made by the people is calculated by multiplying the total quantity of legal tender money by its velocity plus the bank money (cheque, drafts etc) multiplied by its velocity. Velocity of money means the number of hands that one unit of money changes during a given period of time. For example a RS 100 note changes 10 hands in a year, its velocity will therefore be 10. It means that total payment made by this note will be .
RS. 100 * 10 = RS. 1000
According to Fisher, supply of money is determined by the following equation.
MV + M‘V’
M represents the actual money and M’ the bank money where as V and V’ represent their respective velocities.
Demand for money is represented by price multiplied by turnover i.e. total quantity of goods and services sold and therefore demand is determined as:
Demand of money = P x T
Where P is the price and T is the turnover.
Since the value of money is determined at a point where its demand is equal to supply and accordingly Fisher gives the following equation of exchange:
PT = M‘V’ + MV
Or
P = (M‘V’ + MV)/T
According to the above definition / equation, the price level is determined by dividing the total supply of money by turnover.
Criticism
The quantity theory of money is theoretically convincing but practically it is consider as a misleading one.
1. The very assumption in the theory that other things remaining same are incorrect. Fisher assumed money as independent variable where as credit (M’) is a function of business activity i.e. the turnover. It means the turnover increases, the supply of bank or credit also increases and consequently money is not an independent variable.
2. Velocity of money and bank money has been assumed is assumed in this theory to be constant where as they are not so because they depend upon business activity which is never constant.
3. The theory fails to explain as to why during depression the increase in supply of money does not bring a corresponding increase in the price level.
4. According to quantity theory high price is the effect of increase in supply of money which is not always true. Scarcity of goods caused by a fall in production or increase in production with respect to an increase in population also raises the price level.
5. It is argued that Fisher’s equation is only valid in a static economy. The economy becomes static beyond full employment level because the physical production does not increase in such a situation. theextra money if introduced in such a stage of economy is not absorbed by increased quantity of output and consequently the price level is directly affected. This shows that Fisher equation in a dynamic economy is of no use.
Importance of Money
In order to have a comprehensive idea of the importance of money, we can classify it as.
1. Importance to individuals in their daily life.
2. Importance to an economy.
1. Importance to Individuals in their Daily Life
Importance to individuals in their daily life is well established under the following heads
i. Removal of Double Coincidence
Money has removed the problems of double coincidence of wants. An individual because of money is in position to exercise his choice and can purchase or consume a commodity according to their liking.
ii. Convenience in Buying and Selling
Money being a measure of value, an individual can sell his goods for money and purchase the goods he needs through it. The sale and purchase of goods is not confined to with in the borders of a country only, but are also conducted abroad.
iii. Ease in Planning
Money has given an opportunity to an individual to plan his consumption in a way that he gets the maximum satisfaction out of his limited income. Because of money price of every thing is known to him on the basis of which he can ascertain that what he can afford and what he cannot.
iv. An Option for Saving
Money being a store of value helps the individual to make provision for rainy days. During the period of his earning, he may have some thing, which he can use in his old age when his earning has reduced.
v. Recovery Options
Money also helps an individual to cover the gap between income and expenditure intervals, which is done either by withdrawing the past saving or by borrowing. Saving and borrowing have become common and a part of our economic activities.
vi. Possibilities of Specialization
Money has made possible the regional specialization of production on the basis of the most favorable condition principle, which has given birth to international division of labour have reduced the cost, improved the quality and increased the verities of products. Individuals are in a position to consume superior goods at a cheaper price.
vii. Transfer of Value
Money being a measure of value helps the individuals to transfer the value of their fixed assets from one place to another in the country or out side the country. In other words even the immoveable assets have become mobile.
viii. A Source of Income
Because of lending and borrowing practices facilitated by money, the individuals saving become a source of income. The individuals make savings, invest them in productive activities and receive a regular income, which increases their welfare by improving their standard of living.
2. Importance to Economy
The economy of a country is however, benefited by money in more than one-way:
i. Enhancing Exchange Facility
Money enhances the exchange facility and extends the market for goods and services produced in the economy. The extension of market creates demand for goods and services and consequently the resources are fully exploited to increase the output so that the inc4reased demand may be adequately met.
ii. Economies of scale
Money oriented demand provides economics of scale. The economy in such a situation produces goods at a cheaper cost because of the reason that input and output ratio rises.
iii. Increased Opportunities of Employment
Increased volume of production increases the level of employment and income level follows suit. Raised income level stimulates saving and investment and consequently the investment rate in the economy rises.
iv. Facilitate International Trade
Through money international trade is facilitated, which makes the resources of an economy more mobile and such resources are exploited to the maximum extent.
v. Introduction of Lending and Borrowing
Because of money lending and borrowing have become a common practice among the nations of the world. The surplus resources o fan economy moves to another economy, which is deficient in such resources. Flow of resources helps an undeveloped to venture into her development plan. Lending and borrowing practices developed through money, exchange saving and stimulate investment n the economy. As a result the economic growth is accelerated.
Dangers of Money
Money has proved dangers in several ways
1. Economic Instability
Some economists of the view that money is responsible for economic instability. When there was no money, saving was not divorced from investment. Those who saved also invested. But in a monetized economy, saving is done by certain people and investment by some other people. Hence, it does not follow that saving and investment should be equal. When savings in a community exceeds investments, then national income output and employment decrease and the economy is engulfed in depression.
2. Danger of Over-Issue
The main danger of money lies in its liability of being aver issued. The over issue of money may result in inflation. Excessive rise in prices hits hard the consuming public. It endangers speculation and inhibits productive enterprises. It adversely effect distribution of income and wealth in the community so that the gulf between the rich and poor widens.
3. Economic Inequalities
Money has proved to be a very continent tool for amassing wealth and exploitation of the poor by the rich. The misery and degradation has gone to a great extant after the existence of money.
4. Moral Depravity
Money has weakened the moral fiber of the man. The social evil like corruption has proved to be a soul-killing weapon. As said by an eminent German economist Von Mises.
“Money is regarded as the cause of theft and murder”.
Money is itself is not bad, but its possession or debt facilitates corruption and crime.
Gresham's Law
Concept
Gresham’s law can be stated, as
“Bad money tends to drive good money out of circulation when both of them are full legal tender”.
Thus when two kinds of money good and bad circulate together, other things remaining constant, bad money will remain in circulation and good money will go out of circulation.
Classification of Good and Bad Money
Good and bad money may be classified as:
1. Good money is full valued coins of standard wealth and fineness while bad money is the one, which is debased or worn out.
2. Good money may be superior money of higher substance while bad money will be inferior money of less intrinsic value.
Explanation
In the light of the first classification the law may be stated as:
“Whenever legal tender coins of the same face value but of different weight or degree of fineness are in continuous circulation, the light weight or bad coins tend to drive out the full weight fine coins out of circulation”.
Marshal states the law in the light of second classification as:
“ Money which is inferior in respect to exchange or substance value, commonly shows greater tendency in circulation than those which are superior in this respect”.
Application
The law is applicable in three cases:
Under Mono – Metallism
When coins of same metal but of varying weight or fineness or both circulate together at the same face value, it will be the human tendency to keep a brand new coin and give out the depreciated one. Thus the old and worn out coins will tend to drive newly minted full weight fine coins out of circulation.
Under Bi – Metallism
When gold and silver coins are freely circulated as legal tender, then the over valued coin will drive the under value coin out of the game.
Under Paper Currency
When paper money and metallic money circulate together as standard, however paper money being inferior tends to drive metallic money out of circulation.
The reasons for this are:
- Good money is exported to earn profits.
- Good money is hoarded for later adjustments.
- Good coins are melted and sold as bullion.
Exceptions
The law does not operate when:
- There is a shortage of currency.
- When there is strong public opinion against bad money.
Bi Metallism
Definition
Bimetallism is a system of currency under which the price of the monitory unit is regulated with reference to any two metals (generally gold and silver). Both the metals act as a medium of exchange and the standard of value. The two metals remain in circulation side by side. The ratio between their values is fixed and maintained by the currency issuing authority.
Essential Features
The essential features of bimetallism are:
1. Standard coins of two metals, generally gold and silver remain in circulation side by side.
2. Coins of each of the metals remain unlimited legal tender.
3. Generally free coinage of both metals is considered as legal and allowed. But some times free coinage of only one metal is allowed. If it is so then the system is called limping standard.
4. There is a fixed legal ratio of exchange between the two metals e.g. if an American silver coin has 16 g. of silver for every gram of gold in gold coins, the ratio of exchange between the two would be 16:1. Any payment that would be made it would be made keeping in view the ratio between them.