Chapter 5
MONEY
Money: A thing which is commonly accepted
as a medium of exchange is called money.
Example: A rupee in India is money, a dollar in
USA is money.
In olden days, goods were exchanged for goods. There
was no money. The system of exchange were known
as Barter System. But with the increase in human
wants Barter system proved to be inefficient and then
we invented money.
Initially, gold and silver coins were introduced as
money. (Commodity Value)
But it became dangerous to carry gold and silver coins.
So alloy coins and paper money came into existence.
And now we use plastic money. In the form of cash
cards and E-money in the form of electronic transfer
of money.
MONEY- ADVANTAGES
Barter system
Facilitated Exchange
Metallic currency
Exchange became easy
Expenditure increased
Separated the act of sale and purchase
Paper money
No need to keep reserves of gold and silver
Exchange expanded to global level
Investment became easy
Supply of money has become more elastic
E- Money
Printing cost of notes has reduced
Use of paper is reduced
Anytime anywhere net banking
Trade has become flexible
Account tackling becomes convenient
MONEY- DISADVANTAGES
Barter system
Difficulty of double coincidence of wants
Lack of common unit of value
Lack of future payments
Lack of storage of value
High trading cost
Metallic currency
Difficult to pay for large transactions
Commodity value is more than face value
Hard to be split into smaller denominations
Paper money
Excessive circulation causes inflation
Difficult to handle
Possibility of fake currency
Acceptability requires trust of people
E- Money
Cyber crime
Unnecessary purchases
Acceptability issues
MONEY
Money acts as a medium of exchange goods can
be exchanged because of money
Money is used as a measure of value. We decide
price of our goods and services in terms of money
Money is used as a store of value. we save money
in our locker and bank accounts
Money is used as a standard for deferred
payments (Future payments). Deferred
payments are those payments which are to be
made in future
So, money is defined as an instrument that serves as a medium of exchange,
store of value, measure of value and standard for different payments.
“ Money is what Money does”
BARTER SYSTEM OF EXCHANGE
Barter system : It is a system of exchange is a
system in which goods are exchanged for goods.
C-C Economy: it is the economy in which
commodities are exchanged for commodities.
This economy is dominated by barter system of
exchange.
Drawbacks of the Barter system:
1. Double coincidence of wants: It means that a point of time two individuals
should have such goods which they are willing to exchange for the satisfaction
of their wants. So exchange remained under barter system and money came
into existence and vanished this problem.
Drawback of the Barter System
2.Lack of common unit of value: under barter
system it was very difficult to value assets.
Evolution of money has given us a common unit
of value and therefore a system of accounting
3. Difficulty of future payments or contractual
payments: contractual payments were very difficult
under barter system
4. Difficulty of storage of value and transfer of
value: in this CC economy saving is possible only by
way of storage of goods. It involves youth storage
cost as well as the fear of capital loss due to natural
disasters. Transfer of goods is again a difficult task.
Evolution of money has made storage and transport
easier
FORMS OF MONEY
Important forms of money are
1. Fiat Money 3. Full Bodied Money
2. Fiduciary Money 4. Credit Money
Fiat Money & Fiduciary Money
1. Fiat Money: Fiat money refers to that money which is issued by
order order/authority of the government. It is called legal tender
money. It includes all the notes and coins which the people in a
country are legally bound to accept as a medium of exchange. For
example Notes and Coins
Limited Legal Tender Unlimited Legal Tender
(Coins) (Notes)
2. Fiduciary money: Fiduciary money is that money which is accepted
as a medium of exchange because of the trust between the payer and the
payee. For example, Cheques
Full Bodied Money & Credit Money
3. Full Bodied Money: It refers to money in terms of coins whose
commodity value is equal to the money value as and when these are
issued.
For Example, A rupee coin used during the British Period
Money Value (Face Value) = Commodity Value
4. Credit Money: It is that many of which money value is more than
commodity value.
For example, Metal coins that we use today.
Money Value > Commodity Value
FUNCTION OF MONEY
PRIMARY FUNCTIONS SECONDARY FUNCTIONS
PRIMARY FUNCTIONS SECONDARY FUNCTIONS
1. Medium of exchange: Money acts as a medium of 1. Standard of deferred payments: default payments
exchange for the sale and purchase of goods and services. In refer to those payments which are made in the future.
the absence of money goods were exchanged for goods. It has led to the emergence of financial market
Exchange has become much simpler It has led to increase in consumption expenditure and
It has changed the nature of production activity investment expenditure
It has separated the act of sale and purchase
2. Measure of value or unit of value: Value of each good 2. Store of value: Storing Wealth has become easy with the
and services measured in the monetary unit. There was no introduction of money. It was difficult to store wealth in barter
common unit of value in Barter system. system because goods can be wear- out or damaged.
Common unit of value has facilitated comparison of market Storing wealth helps in future investments
value of different assets It has induced people to save more
It has facilitated the estimation of national income and
related aggregates
3. Transfer of value: Money value can be conveniently
transferred to any part of the world.
It has led to global financial market
It has encouraged the growth of MNCs
It has facilitated foreign direct investment
It has enhanced mobility of capital across different regions of
the country
FUNCTION OF MONEY
1. Static functions of money
2. Dynamic functions of money
means conventional
includes those functions of
functions of money.
money which gives: stability to
Includes primary and
the economy and increase the
secondary function of
pace of GDP growth
money
SUPPLY OF MONEY
Supply of money is a stock concept. It refers to total stock of
money by the people of a country at a point of time.
It does not include:
Stock of money held by the government, and
Stock of money held by the banking system of a country.
Government and Banking system are the suppliers (producer) of
money.
Supply of money refers to
that stock of money which
is held by those, who
demand money, not by
those who supply money
Suppliers of Money are:
CENTRAL BANK OF THE COUNTRY (RBI COMMERCIAL BANKS
in India)
Commercial banks are the second
Reserve Bank of India is the principal
source of money supply
supplier of money
It issues all currency notes except ₹1 note Commercial bank do not issue currency
but they create money by way of
RBI issues currency on the basis of
demand deposits
minimum reserve system. It maintains a
minimum reserve of rupees 200 crore in These deposits are chequeable deposits
the form of gold and foreign securities. Money created by the commercial
Value of gold reserve must be Rs. 115 banks by way of demand deposit is
crore called bank money
THE GOVERNMENT
Govt. of India is the third source of money
supply in India. Ministry of Finance issues
all coins and one rupee note.
MEASURES OF MONEY SUPPLY
There are 4 alternative measures of money supply. Only Net demand
M1,M2,M3 and M4. deposits are taken as a
part of money supply
M1 Measure of Money Supply because net demand
M1 = C+DD+OD deposits do not include
Inter-banking claims.
C: Currency held by the general public Gross demand deposits
include inter-banking
DD: Demand deposits of the people with claims
commercial banks, do not include Fixed
deposits
OD doesn’t include
OD: Other Deposits it includes: deposits of the
government of the
Demand deposits of public financial institution like
NABARD with RBI, [do not include commercial bank] country with RBI
and deposits of the
Demand deposits of foreign central banks and foreign country’s banking
government with RBI
system with RBI
Demand deposits of international financial institutions
(IMF, World Bank) with RBI
M1 MEASURE OF MONEY SUPPLY
Other Deposits
Currency with the with Reserve
Public Bank
Demand Deposits
of the People with
the Commercial
Banks
Demand deposits with Demand deposits with
Demand deposits with
Reserve Bank of foreign Reserve Bank of
Reserve Bank of public
central banks and international financial
financial institution
government institutions
Difference between
Term Deposits and Demand Deposits
Basis Term/Fixed Deposits Demand Deposits
Time Term Deposits are for a fixed Demand deposits are not
period of time. for any specific period of
time
Withdrawal Depositors cannot withdraw Depositors can withdraw
of Money money as and when needed money as and when needed
Nature of These are not chequeable These are chequeable
deposits deposits deposits These are saving
accounts deposits and
current account deposits
MEASURES OF MONEY SUPPLY
M2 M1 + Deposits with Post Office Saving Bank
Measurement Account
M3 M1 + Net Time Deposits with the
Measurement Commercial Banks
M4
M3 + Total Deposits with Post Office
Measurement
M1 and M2 = Narrow Money
M3 and M4 = Broad Money
M3 = Aggregate Monetary Resources
BANK MONEY and HIGH POWERED
MONEY
BANK MONEY: refers to demand
deposits of the people with the
commercial banks. These are
chequeable deposits HIGH POWERED MONEY:
Currency held by the public
Vault Cash of commercial
banks
Cash reserves of the
commercial banks with RBI
This is called “Monetary base”
or “Base money” or “Reserve
money”
