Functions of Money

Medium of Exchange

The introduction of money as a medium of exchange has eliminated all the difficulties and disadvantages associated with the barter system. All goods and services are now being exchanged with help of money. Introduction of money has divided the process of exchange into two parts, viz., sale and purchase. Any person who wants to exchange something for another, first of all sell his commodity for money and then with the help of money buy the other commodity. While one commodity has been exchanged for the other, yet this exchange has not been a direct one. The exchange has been done a direct one. The exchange has been done through the medium of money. Thus, money performs the important function of the medium of exchange.

With the introduction of money as a medium of exchange, the first difficulty of barter, viz., lack of double coincidence of wants, has been overcome. Now, it is not necessary that one person should posses what the other wants and at the same time want, what the other possesses. Exchange goes on quite smoothly even if there is no double coincidence of wants. One has merely to sell his commodity to the person who wants it and then with the help of money acquired from this sale the can purchase whatever he wants and from whomsoever the likes to buy.

The double coincidence of wants, with is required for barter, is unnecessary when a medium of exchange is used.

To serve the medium of exchange, money must have the following characteristics:

• It must be readily acceptable in purchase and sale of goods and services. This means no one should hesitate or refuse to accept money. This is possible only when money has intrinsic value i.e., the value of metal contained in money as a coin is enough to make it acceptable (as in gold and silver coins in the past). However, this acceptability is now ensured by making money a legal tender, i.e., money has been made acceptable by law and government order and hence no one can refuse it. This is the case with present-day currency, viz., coins and currency notes that are ‘fiat money’, i.e., backend up by government’s order (fiat) making them acceptable.
• Since, money has to be carried around over distance to make purchases and sales (conduct transactions), the monetary unit must have value relative to its weight and carrying cost. Thus, it may not be possible or inexpensive to carry wheat bushels or steel bars or even animals (as in the earlier days these were used as medium of exchange) for conducting transactions, modern money, currency notes of higher denomination have this property of carrying around with ease for making payments.
• Money must be divisible into smaller fractions. This is so because some transactions require very small value in exchange. The smaller denomination currency notes and coins make money divisible.
• Lastly, money should not be amenable to easy counterfeiting, i.e., currency should not be capable of being faked (copied, minted or printed illegally) and circulated easily. However, in spite of best precautions, some fake currency does circulate in the market.

Measure of value

Apart from being an excellent medium of exchange, money also serves as a common measure. The value of all commodities is expressed in terms of money. In case of barter, the value of each one of the goods had to be expressed in terms of all other goods. This made the comparison of the value of different goods impossible because they are not expressed through a common index. Beside the number of goods to be exchanged being fairly large, the number of values assigned to each commodity in terms of the others, becomes very large.

Store of Value

Money serves as an excellent store of value. It enables the individuals to store wealth for an indefinite period of time without any deterioration. If wealth is stored in terms of goods then either the goods may perish or some cost may have to be incurred in the maintenance cost of the value of these goods. In the first case, the value of wealth stored would have declined over a period of time, while in the second case it would have been expensive to store value. But with the use of money, the value can be stored easily because money is neither perishable nor requires any maintenance expenditure.

Standard of Deferred payments

Money serves as a standard of deferred payments. Not only the payments to meet the preset obligations are made in terms of money, but also contracts for future payments are made in terms of money. All the commitments relating to the further are made in monetary terms because it is though that the value of money is more stable that the value of other goods and services. In the words of Benham,”Contracts, including loans are usually made in terms of money.” Money is thus the basis of all credit.

Liquidity

Another important aspect of money which is emphasized by the modern economist is its liquidity. Liquidity refers to that quality of money by virtue of which it is most readily convertible into other commodities. A person possessing money can purchase whatever he likes. No one can refuse to accept money while he is at liberty to refuse or accept other goods in exchange for goods. Thus, money is the most liquid of all the assets and therefore all people prefer to keep a certain amount to money with them to meet their day-to-day requirements of goods and services.

Basis of Credit Structure

Money serves as the basis of credit. The entire super structure of credit in the modern economies is founded on the basis of credit. Finally, money helps the people to keep their wealth in the most liquid form.