What are the Functions of Money?
The primary role of money, as one of the functions of money, is to act as a medium of exchange. In a large economy, barter trade can be extremely difficult because people would need to spend a lot of time finding the right person to exchange goods or services with. Money simplifies this process, making trade easier and more efficient.
Primary Functions of Money
1. Medium of Exchange: Money is used to buy and sell goods and services. It makes trade simple by eliminating the need for bartering.
2. Measure of Value: Money provides a common way to measure and compare the worth of goods and services. This helps in setting prices and valuing items.
Secondary Functions of Money
1. Store of Value: Money allows people to save their wealth for future use. It can be kept for a long time without losing its value, making it easy to use when needed.
2. Standard of Deferred Payment: Money makes it possible to pay for goods or services later. It is widely accepted for settling debts over time.
3. Transfer of Value: Money helps transfer wealth from one person or place to another. It makes it easier to trade across distances or give gifts and payments.
5 Functions of Money
1. Medium of Exchange: Money is used to buy and sell goods or services, making trade simple and efficient by replacing the barter system.
2. Measure of Value: Money provides a common standard to determine and compare the worth of goods and services, helping set clear prices.
3. Store of Value: Money can be saved and used in the future without losing its value, allowing people to preserve wealth over time.
4. Standard of Deferred Payment: Money is used to make payments for goods or services at a future date, making it suitable for settling debts.
5. Transfer of Value: Money enables the transfer of wealth from one person or place to another, facilitating trade and financial transactions.
Conclusion
Money is an important part of our daily lives and the economy. It helps us buy and sell things easily, acts as a way to measure the value of goods, and makes trading simple. Money also allows us to save for the future, pay for things later, and transfer money to others. These functions make money essential for smooth transactions and economic growth.
FAQs on Functions of Money in Economics
1. What are the primary functions of money in an economy?
The primary functions of money are the most fundamental roles it plays in an economy. They directly address the core problems of a barter system. The two primary functions are:
- Medium of Exchange: Money acts as an intermediary in the sale and purchase of goods and services, eliminating the need for a 'double coincidence of wants'.
- Measure of Value (or Unit of Account): Money provides a common standard for measuring and expressing the value of all goods and services, making it easy to compare prices.
2. What are the secondary functions of money as defined in economics?
Secondary functions of money, also known as derivative functions, are built upon its primary roles. These include:
- Standard of Deferred Payment: Money is used as a standard for payments that are to be made in the future, such as loan repayments or salary contracts.
- Store of Value: Money allows individuals to save purchasing power over time. It is a convenient way to hold wealth, although its value can be affected by inflation.
- Transfer of Value: Money makes it easy to transfer purchasing power from one person to another or from one place to another.
3. How exactly did the introduction of money solve the key problems of the barter system?
Money effectively solved the major inefficiencies of the barter system. Firstly, it eliminated the double coincidence of wants, as a seller no longer needs to find a buyer who has the exact good they desire. Secondly, it provided a common measure of value, making it simple to price goods and services. Previously, every item had to be valued against every other item. Lastly, it offered a viable store of value, as perishable goods in a barter economy could not be saved for future use.
4. Can you provide a real-world example for each main function of money?
Certainly. Here are simple examples for each key function:
- Medium of Exchange: Using ₹100 to buy groceries at a store.
- Unit of Account: A coffee shop pricing a cappuccino at ₹150 and an espresso at ₹120, allowing customers to compare their values.
- Store of Value: Saving ₹5,000 in a bank account to pay for a trip next month.
- Standard of Deferred Payment: Taking out a student loan where you agree to repay a specific amount of money over the next five years.
5. What is the key difference between money's function as a 'unit of account' and as a 'medium of exchange'?
The main difference lies in their application. The 'unit of account' function is abstract; it is about pricing and measuring economic value. For example, a car's price tag of ₹8,00,000 uses money as a unit of account. The 'medium of exchange' function is the physical or digital act of using that money to complete the transaction—handing over the ₹8,00,000 to purchase the car. One is for measuring, the other is for exchanging.
6. Under what circumstances can money fail to be a good store of value?
Money can fail as a good store of value, primarily during periods of high inflation or hyperinflation. When the general price level of goods and services rises rapidly, the purchasing power of money decreases. This means that the money you have saved will buy you significantly fewer goods in the future than it can today, undermining its function as a reliable store of wealth.
7. What are the contingent functions of money in a modern economy?
Contingent functions are modern or advanced functions that money performs, which depend on its primary and secondary roles. Key examples include:
- Basis of the Credit System: Banks create credit based on their cash deposits, which is only possible because money is accepted as a standard of payment.
- Distribution of National Income: Money facilitates the distribution of rent, wages, interest, and profit among the factors of production.
- Maximisation of Utility and Profit: Consumers and producers use money to make rational decisions to maximise their satisfaction and profits by comparing marginal utilities and costs.
8. How does money's role as a 'standard of deferred payment' support economic activities like loans and investments?
This function is crucial for a modern economy. It provides a stable and accepted unit for settling future debts and contracts. For loans and borrowing, it allows lenders and borrowers to agree on a fixed monetary value for future repayments. For investments, it enables contracts that promise future returns in a clear, quantifiable monetary term. Without this function, long-term financial planning and credit markets would be nearly impossible to operate.
