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”.

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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.

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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.
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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 its 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 unfavourable.
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."
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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.

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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. the extra 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.

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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 places 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.
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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 monetised 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.
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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.

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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.