Money

MEANING AND EVOLUTION OF MONEY

A thing which is commonly accepted as a medium of exchange is called money. Example: A

rupee in India is money, as it is a commonly accepted medium of exchange here. Likewise, a
dollar in USA ismoney, as it is a commonly accepted medium of exchange there.In olden
days, goods were exchanged for goods. There was no money.Thus, a cobbler would make
shoes in return for wheat from the farmer;a farm worker would get grains as a reward for
his labour, and so on.
This system of exchange was known as barter system. But with themultiplicity of wants (and
greater need for exchange), barter system (a system where goods were exchanged for
goods) proved to be an inefficient system of exchange. It is then that we invented money-a
common medium of exchange. Now goods were not sold for goods.Instead, goods were sold
for money. Initially, coins of gold and silver were introduced as money. Subsequently, alloy
metal was used for coinage, along with paper money. And, now is the age of plastic money
(in the form of cash cards), or e-money in the form of 'electronic transfer of money' by way
of credit/debit entries in the bank accounts. Thus, the origin (and evolution) of money is
related to the need to facilitate exchange.

Origin of money
Though initially invented as a medium of exchange, gradually money found its other uses as
well:
• Money is used as a store of value. Or, money is used as an instrument of saving.
• Money is used as a measure of value. Value of goods and services is expressed in terms of
money.
• Money is used as a standard for deferred payments ( deferred payments are those
payments which are made sometimes in the future).
Owing to its multiple functions, money has acquired a wider definition than merely a
medium of exchange. It is defined as an instrument that serves as a medium of exchange,
store of value, measure of value and standard for deferred payments. Briefly, it is said that
'money is what money does'.

Definition of Money
Money is what money does. It is defined as an instrument that serves as a medium of
exchange, store of value, a measure of value and a standard for deferred payments.

Basic Functions of Money

The definition of money conveys the basic functions of money These are:

(i) Money acts as a medium of exchange,

(ii) Money serves as a store of value (people save in terms of money),

(iii) Money is a measure of value: market price of goods and services is expressed in terms of
money, and
(iv) Moneyserves as a standard for deferred payments (future payments)· when business
contracts are signed on the basis of future payments, money acts as an instrument for those
payments.

Barter System of Exchange

Barter system of exchange is a system in which goods are exchanged for goods. If (as a
farmer) you have surplus production of rice, you are to look for a person who needs rice,
and at the same time has (say) cloth, which you need for yourself. It means 'double
coincidence of wants': your want for cloth must coincide with somebody's want for rice, and
you must have surplus of rice and somebody must have the surplus of cloth. How difficult it
is! What do you do these days? As a farmer, you sell rice for money, and as a cloth
merchant, you sell your cloth for money. With money in hand, you buy whatever you wish
to buy. Thus, rice is exchanged for money, cloth is exchanged for money. Money acts as a
common medium of exchange. No such common medium of exchange exists in the C-C
economy (commodity for commodity exchange economy) where goods are exchanged for
goods.

C-C Economy
C stands for commodity C-C economy is the one in which commodities are exchanged for
commodities or in which goods are exchanged for goods. C-C exchange refers to Barter
System of Exchange. Hence, C-C economy is an economy dominated by Barter System of
Exchange.

Drawbacks of the Barter System and their Elimination

Following are the principal drawbacks of barter system of exchange. It is with the
introduction of money that these drawbacks have been eliminated.

(1) Double Coincidence of Wants: Double coincidence of wants is a core characteristic of

the barter system of exchange. Double coincidence of wants implies that (at a point of
time), the two individuals are in possession of such goods which they are willing to exchange
for the satisfaction of their wants. But it is not always so simple. It is not so simple to find a
person who wants your horse and at the same time has a cow that you want to buy.
Accordingly, under the barter system, exchange remained extremely limited. With the
emergence of money (as a medium
of exchange), the problem of double coincidence of wants has vanished. Money as a
medium of exchange has separated the acts of sale and purchase.

(2) Lack of a Common Unit of Value: What is the value of your car? You can reply:   5 lakh.
Can you give the same answer in a barter system of exchange? Certainly not. Under such a
system, your car would be valued in terms of horses, cows or buffaloes, simply because
there is no money (or a common unit of value).
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: These days you hire a worker
and strike a contract to pay him (say)  10,000 p. m. What do you do in a barter system?
Would you decide to pay him in terms of tables or chairs, in terms of rice or wheat, in terms
of drugs or chocolates? Contractual payments or future payments would certainly be very
difficult under barter system of exchange. Evolution of money has facilitated contractual
payments.

(4) Difficulty of Storage of Value (Saving) and Transfer of Value: In the C-C economy,
saving is possible only by way of storage of goods. It involves substantial storage cost as well
as the fear of capital loss (owing to natural disasters). Further, what happens if you are to
transfer your saving from one place to the other?
• Money has led to the expansion ofexchange.
• Expansion of exchange has led to expansion of the markets for goods and services.
• Expansion of market has led to expansion of the scale of output.
• Expansion of the scale of output has led to GDP growth. Implying growth of the economy.

FORMS OF MONEY
Some important forms of money are described as under:
(i) Fiat money and fiduciary money, and
(ii) Full bodied money and credit money.

(i) Fiat Money and Fiduciary Money

Fiat money refers to that money which is issued by order/ authority of the government. It
includes all notes and coins which the people in a country are legally bound to accept as a
medium of exchange. Fiduciary money is that money which is accepted as a medium of
exchange because of the trust between the payer and the payee.
Example: Cheques are fiduciary money as these are accepted as a means of payment on the
basis of trust, not on the basis of any order of the government.

(ii) Full Bodied Money and Credit Money

Full bodied money refers to money in terms of coins whose commodity value is equal to the
money value as and when these are issued.
Example: A rupee coin during the British period in India was made of silver. Commodity
value of the coin was equal to its money value at the time of its issuing. Or, the market value
of the silver contained in the coin was equal to 1.
Credit money refers to that money of which money value is more than commodity value.
Example: What is the market value of the metal that the rupee coin is made of in India?
Obviously, much lower than the money value of the rupee coin. Otherwise, people would
have melted the coins and sold the metal in the market at a price greater than one rupee.

SUPPLY OF MONEY
Supply of money is a stock concept. It refers to total stock of money (of all types) held by the
people of a country at a point of time.
It is important to note that the supply of money does not include:
(i) stock of money held by the government, and
(ii) stock of money held by the banking system of a country. Because, government and the
banking system of a country are suppliers of money, and the stock of money held by the
suppliers of money is never treated as a part of the supply of money in the country.
Supply of money includes only that stock of money which is held by people, other than
suppliers of money themselves. In other words, supply of money refers to that stock of
money which is held by those, who demand money, not by those, who supply money.
ii) the banking system of a country, including both the central bank (which is the note
issuing authority) and the commercial banks (who add to the supply of money through
demand deposits).

Measures of Money Supply

In India, there are four alternative measures of money supply, popularly known as M 1, M2,
M3, and M4. Of these, only M1 measure is discussed here, as prescribed in the syllabus. M 2,
M3 and M4 measures are given in 'Ability Zone' of the chapter for general reference.

M1 Measure of Money Supply

According to M1 measurement, money supply includes the following components:

M1 = C +DD+ OD

Here,
C: It refers to currency held by the public. It includes coins as well as paper notes.
DD: It refers to demand deposits of the people with the commercial banks. These are
chequeable deposits which can be withdrawn or transferred on demand.
OD: These are other deposits which include:
(i) Demand deposits with RBI of public financial institutions like NABARD (National Bank for
Agriculture and Rural Development).
(ii) Demand deposits with RBI of foreign central banks and of the foreign governments.
(iii) Demand deposits of international financial institutions like IMF and World Bank.
Specifically, OD does not include:
(i) deposits of the government of the country with RBI,
(ii) deposits of the country's banking system with RBI.

Net Demand Deposits and Gross Demand Deposits

Distinction may be drawn between gross demand deposits and net demand deposits with
the commercial banks. Gross demand deposits include inter-banking claims: claims of one
bank against the other. Net demand deposits do not include inter-banking claims. Inter-
banking claims are not a part of demand deposits of the people

Term Deposits and Demand Deposits

Term deposits are different from demand deposits:
(i) Term deposits are always for a specific period of time, like fixed deposits for a period of
one
year or two years. Demand deposits are not for any specific period of time.
(ii) Depositors cannot withdraw money (in fixed deposits) as and when needed. Money in
demanddeposits can be withdrawn as and when needed.
(iii) Term deposits are not chequeable deposits. Depositors cannot sign a cheque against
thesedeposits. Demand deposits are chequeable deposits. These are:
(a) saving account deposits,and
(b) current account deposits. Depositors can sign a cheque and withdraw/transfer money
from these accounts.

M2, M3, M4 Measures of Money Supply

M2 Measurement
M2 is a boarder concept of money supply compared to M1. Besides all the components of M1, it
also includes savings of the people with the post offices.
Thus,

M2 = M1 + Deposits with Post Office Savings Bank Account

M3 Measurement
M 3 is also a broader concept of money supply compared to M1. Besides all the components of
M1, it also includes (net) time deposits (or fixed deposits/term deposits) of the people with the
commercial banks.
Thus,

M3 = M1 + Net Time Deposits with the Commercial Banks

M4 Measurement
M 4 concept of money supply is stil broader - it is broader than even M 3 .Besides all the
components of M 3, it also includes total deposits with the post offices (other than in the form of
National Saving Certificate).
Thus,

M4 = M3 + Total Deposits with Post Offices

(Other than in the form of National Saving Certificate)