Functions of Money

 

Functions of Money

The functions of money can be categorized into three groups:

1. Primary function,
2. Secondary function, and
3. contingent functions.

Within the primary function, there are two key roles of money:

1. Medium of exchange: Money serves as a widely accepted means for facilitating transactions and exchanging goods and services.
2. Measure of value: Money provides a standardized unit of measurement for determining the worth or value of goods, services, and assets.

Primary Functions of Money

Primary Functions of Money:

Money serves two primary functions: as a medium of exchange and as a measure of value.

Money as a Medium of Exchange:

The function of money as a common medium of exchange facilitates the buying and selling of goods and services. This function effectively solves the problems associated with a barter system. It is the most important and unique function of money, which distinguishes it from near-money assets. Money divides the exchange process into two parts: sale and purchase.

Money as a Measure of Value:

Money acts as an instrument for measuring the value of goods and services in terms of their monetary worth. Without money, measuring the value of goods and services for the purpose of exchange would be tedious. The market offers thousands of goods, and it would be extremely difficult to exchange them without a common medium for valuing them. If one person wants to offer their product to different people, they would need to keep thousands of values for their single product to effectively conduct their business. Money resolves this problem by serving as a common medium. With the introduction of money, a trader needs to assign only one value to each of their goods and services. Additionally, it is worth noting that different goods are measured in different physical units, such as liters, kilograms, meters, etc. The comparison of the value of goods with different physical units becomes possible when you know the monetary value of each item.

Knowing the monetary value of goods allows for the comparison of goods in different regions or at different times. The use of money prices also aids in estimating national income by aggregating the values of a wide variety of goods and services that are measured in different physical units.

However, money's role as a measure of value can only be satisfactory when its own value (i.e., purchasing power) remains stable over time. The continuous rise in the general level of prices worldwide has made money a poor measure of value.

Secondary Functions of Money

The secondary functions of money are as follows:

1. Money as a standard of deferred payments
2. Money as a store of value
3. Money as a means of transferring purchasing power

The secondary functions of money are as follows:

1. Money as a Standard of Deferred Payments: Money not only facilitates current transactions of goods and services but also credit transactions. It enables credit transactions when goods are exchanged for future payments. Nowadays, deferred payments have become a part of our lives, such as loan installments, pension contributions, insurance premiums, etc. Money can serve as an effective standard for deferred payments. However, for this purpose, the value of money should remain stable. If prices experience sharp increases or decreases, resulting in significant fluctuations in the value of money, it would render money a poor standard for deferred payments.

2. Money as a Store of Value: We can store a portion of our present earnings in the form of money to be used in the future. Money represents generalized purchasing power and is a highly liquid asset. It maintains stability in value and is useful for purchasing goods and services to satisfy future needs. Additionally, money can be stored for a longer period and requires less space compared to other goods. Therefore, accumulating wealth in the form of money is convenient, as it can be easily converted into any desired asset at any time. Money serves as a bridge from the present to the future, as saving money today allows us to shift our purchasing power from the present to the future.

3. Money as a Means of Transferring Purchasing Power: Money is the most convenient form for transferring value from one person to another and from one place to another. It is lightweight, high in value, and occupies less space compared to other goods. Furthermore, money is universally accepted regardless of location. For instance, transferring thousands of kilograms of food grains would be time-consuming, expensive, and prone to wastage. On the other hand, transferring the value of that same quantity of food grains in the form of money is less costly and can be easily done through a check or bank draft. Hence, money acts as a means of transferring purchasing power.

Contingent Functions of Money

The contingent functions of money can be classified as follows:

1. Distribution of National Income
2. Basis of credit system
3. Maximization of utility and profits
4. Money imparts liquidity and uniformity to assets

Contingent Functions:

1. Distribution of National Income: In the modern world, people come together to establish business organizations where they contribute their money, efforts, skills, and space, among other things. When these organizations generate profits, it is crucial to distribute the income among the individuals according to their respective contributions. Money plays a significant role in facilitating the distribution of national income among those involved in its production. This income is divided and distributed in the form of rent, wages, salaries, interest, and remuneration. Determining and remunerating those who have contributed machinery, property, or materials can be challenging, but it becomes easier by assigning monetary value to such assets and distributing income proportionately. Thus, money aids in the distribution of national output among the contributors.

2. Basis of Credit System: The present-day money, including coins, currency notes, cheques, and bank drafts, represents a promise to pay. The modern economy relies on this promise to pay. One area of a bank's function is to receive money from depositors and lend it to individuals or businesses in need of funds for their operations or purchases. Banks charge a fixed or variable rate of interest for this service, and depositors earn interest on their deposits. Therefore, money serves as the foundation of the credit system.

3. Maximization of Utility and Profits: Farmers who engage in agriculture and focus on producing one or two types of crops in large quantities can enhance their utility by selling their harvest for cash. Money allows them to satisfy various needs and desires, while holding onto food grains limits their utility. Similarly, producers of goods can calculate production costs in terms of money value and set profitable selling prices, enabling them to maximize their profits. Hence, another function of money is the maximization of utility and profits.

4. Money Imparts Liquidity and Uniformity to Assets: Money provides a convenient form for holding wealth since it can be used to purchase any asset at any time. Likewise, assets can be converted into money. Therefore, money is the most liquid form of asset. Additionally, money enables the calculation of a person's wealth by determining the monetary value of their properties and possessions. By calculating the money value of all assets, the total wealth of an individual or a country can be ascertained. Thus, another function of money is providing liquidity and uniformity to assets.