Concept of Money in economics – Comprehensive guide

The page contains information about following questions:

  • Money as defined by different economists
  • Functions served by money
  • Criteria / characteristics of good money
  • Different types of money in modern era
  • Merits and demerits of credit / plastic money
  • Definition

    Different economists have defined “what is money?” Following are some of definitions:

    According to Professor G. Crowther “Money is a thing which is acceptable as a medium of exchange and which can measure the value and can also be stored”.

    According to Professor Ely “Everything which is circulated as medium of exchange among the people and which is the standard of payments of debts is called Money”.

    According to Professor Fisher “Money means the payment for things and services and the payment of debts in an acceptable manner”.

    According to Professor Meier “Money is a thing which is acceptable in granting and returning of debts”.

    From above definitions we can conclude that any item / object that have following two characteristics should be called money:

    1. It should circulate as a medium of exchange and must be accepted by everyone without any hesitation.
    2. It can be stored and can serve as the measure of value.

    Functions of Money:

    In modern days, money serves the following functions:

    Medium of Exchange:

    The most crucial function of the money is that it must circulate among people as a medium of exchange. People must accept money without any hindrance as an exchange for their products and services. In any country money must be able to serve as a medium of exchange for buying and selling anything, people must accept it for transactions.

    Common Measure of Value:

    The second function of the money is that it should serve as a common measure of value for everything; means the value of anything must be measured with the yardstick of money. For example: If apple is 1$ per kg, it means the value of apple is 1$. Value of anything can be determined by the purchasing power of money.

    Store of Value:

    The third important function that money serves is store of value. The goods can be stored according to the value of money because money is not perishable item. People can store money from their income so that they can use this money in any case of emergency or any kind of other need.

    Standard of Deferred Payments:

    Another function which money serves is its use as a standard of deferred payments. Nowadays, millions of dollars are carried out as loan and there is no problem in return of loan.

    Unit of Account:

    Money is used for daily accounts. So, it is very easy to determine the prices of goods with the help of money. Money helps an individual to calculate his/her income according to the value of the money. For example: If a person’s salary is 10000$, price of apples is 1$ per kg and the price of 1kg milk is 2$ all such calculations can be made by knowing the value of money.

    Most Liquid Asset:

    According to Professor Keynes, money is the most liquid asset; there is not a single thing as a match for it because people accept money anywhere immediately, without any hesitation. Other things even if they serve money cannot be accepted immediately such as bonds, gold and silver etc. People hesitate to accept such things because they take time to fulfil their needs and demands.

    Guarantor of sovereignty:

    According to Professor Keynes, money also serves as a guarantor of good fame and sovereignty. A person with more money has more respect and value as compared to the person with less money. Even banks grant loans on the basis of financial status of person.

    Mode of government payments:

    Government payments are also made in the form of money. Tax received by the government of country is also in the form of money. Government investments, salaries and all other financial receipts are made in the form of money. Without having money of a country it is impossible to run the state as an independent body.

    Mode of transfer payments:

    As compared to houses, lands or some kind of other property money can be moved from one place to another place very easily and effortlessly.

    Characteristics of Good Money:

    Following are the few characteristics which good money of a country should serve:

    1. Money should be accepted by anyone at anywhere within the state without any hesitation.
    2. It is necessary for good money to be durable and unperishable.
    3. Good money must have the quality of portability. (Easy to transport).
    4. Good money should have the characteristic of convertibility. It must be easy to transform money in different shapes.
    5. It is important for good money that its value does not change even it is divided into small parts.
    6. Good money must be homogeneous in its different units and its value must be equal into its all units in daily market.
    7. Anything which is supposed to serve as good money must have a stable value and its value should not change drastically.

    Types of Money:

    Following are the few types of money:

    Metallic Money:

    It includes all kind of coins made by any metal which are serving as money and are authorized from the government of a country.

    Standard Money:

    By standard money we mean the money whose face value is equal to its real value. For example: In the early days of British in India, the coins of silver have the same value in market as it has the face value. Also Arab gold coins and Dinars have the same value with their face value.

    Token Money:

    It is the coin whose value is more than its real value. For example: 5 rupee coin in Pakistan has more face value as compared to its real value.

    Paper Money:

    Paper money consists of currency notes issued by the state bank of a country. These notes have specific appearance so that they cannot be rejected by anyone. Although central bank of a country guarantees that these notes have the same face and real values but in reality this does not happen often. Paper money has the following two types:
    Convertible Paper Money:
    These kinds of currency notes can be converted into gold and silver. Central bank guarantees that these notes are convertible according to the demand.
    Inconvertible Paper Money:
    Such notes are issued by the government of a country and these notes are not convertible into silver and gold. Government does not keep any gold and silver as a reserve for such notes.

    Legal Tender Money:

    The money which people are bound to accept is called Legal Tender Money. If any person rejects to accept such money, he is considered as a criminal. It has following two types:
    Limited Legal Tender:
    It is the money whose limit has been set by the government of a country and nobody is bound to accept the money beyond such limit.
    Unlimited Legal Tender:
    Such money can be used as a transaction without any limit. It must be accepted on any cost by everyone in a country.

    Near Money:

    It is the type of money which is not circulated as money in a country but possesses the ability to be converted into money at the time of use. For example: Government bonds, shares and fixed deposits etc. we do not call them money because they are unable to serve as money directly, they can only be utilized after selling.

    Credit Money:

    It is a kind of money which circulates in the market on the basis of trust. This is an applied transaction in which payment is supposed to be made in future. Credit money is of following two types:
    Verbal Promise:
    In this case there is no written statement given by borrower, lender has complete trust in the borrower. Verbal promise is usually made to well-known person such as family and friends.
    Written Promise:
    In the case of written promise borrower of a commodity gives a written statement, in which he/she assure that he/she will pay the money in a specific time. Written promise of credit money has two types:

    1. Traditional Instruments:
    Traditional instruments of written credit money include the following types:

    a. Book Account:
    The simplest form of credit money is book account. Usually people purchase common goods from the shopkeeper and shopkeeper just write down this purchase in his/her book, which is known as book account. Shopkeeper makes book account for only well-known people in the market.

    b. Promissory Note:
    In the promissory note borrower of a commodity gives a written statement, in which he/she assure that he/she will pay the money in a specific time. This written statement is called promissory note.

    c. Bill of Exchange:
    Businessmen usually do not pay money for the goods which they purchase from a seller. The seller just writes a statement in which they demand a specific amount of money after a certain time. This statement can be taken to any commercial bank and cash can be withdrawn from the bank. There are the few types of bill of exchange:

    d. Time Bill:
    In this type of bill of exchange payment is supposed to be made in a specific time limit e.g. 6 months, one year etc.

    e. Face Bill:
    In this type buyer have to pay the money for a good after receiving it. For example: While ordering pizza, income is made on delivery not in advance.

    f. Domestic Bill:
    In this type traders from the same country use bill of exchange instead of cash. Payment through bill of exchange is safer than the cash payment.

    g. Foreign Bill:
    Bill of exchange used in the trade between two or more countries is known as foreign bill. The duration of foreign bill is usually 90 days. The person who sends the bill is called Drawer and the person who receives it is called Drawee.

    h. Cheque:
    Cheque is an order from the issuer to his/her bank to give the money written on the cheque to the presenter of the cheque. For issuing a cheque, there are following two necessities:
    1. The issuer of the cheque must have enough money in his/her account so that payment written on the cheque could be made.
    2. All the entries especially signature of the issuer must be accurate otherwise cheque will be rejected by the bank.

    Cheque has the following four types:

    i. Bearer Cheque:
    Usually this type of cheque is used to withdraw cash from the bank. In this cheque the word bearer is written, presenter of the cheque must be paid by the money demanded according to the cheque.

    ii. Order Cheque:
    In this type the word bearer is replaced with the word order and only the person whose name is written on the cheque is allowed to withdraw the money from the bank.

    iii. Cross Cheque:
    In this type cash cannot be withdrawn, the bank transfer money from the account of issuer of the cheque to the account of presenter of cheque. In this cheque two parallel lines are drawn on the top left corner of the cheque.

    iv. Transfer Cheque:
    Banks issue a traveler cheque for travelers, so that traveler is able to deposit money in any bank and bank gives him/her a cheque which is acceptable everywhere.

    i. Bank Draft:
    People also use draft to transfer their money or for payments. A person who gets draft first deposit the money in the bank and then bank orders to its branch or another bank for payment. Bearer gets the money from the bank. This draft can be sent by post or hand.

    j. Bonds or Securities:
    A written assurance from the government of a country after getting money from people or banks is called securities. These securities can be sold in stock market and money can be received. Bears name, date of payment and rate of interest is written on the securities.

    2. Foreign Instruments:
    Foreign Instruments of credit money has the following five types:

    a. ATM Cards:
    ATM stands for Automated Teller Machine. ATM cards are also known as plastic money. These cards are generally used to withdraw money from the account and to know about mini-statements of account balance. Any person with holding the ATM card can transfer money from his/her account to any third party. ATM cards can also be used as Debit cards.

    b. Credit Cards:
    Credit cards are also known as plastic money. This card has a magnetic strip on it which is issued by a bank or any other business organization. The possessor of credit card can buy goods and services according to his/her need without paying any money at that moment, payment can be made in future. To become the owner of credit card, customer must have to open his/her account in the concerned bank. VISA is the first company recognized internationally as the issuer of credit cards. The banks and other business organizations charge the facility of credit card from the account of credit card possessor.

    c. Online Banking:
    With the help of internet banks can provide their facilities and activities to the customers at their door step. Through online banking transactions such as balance in account, payments of bills etc. can be made via internet without any effort. Some customers can also get loan and credit through online banking.

    d. M.T:
    MT stands for Mail Transfer. It also means transfer of money. There is no special tool in it, for the transfer of payments. This method of transfer is generally used by banks for their internal affairs. In this method concerned bank just transfer the payment by mail after few necessary precautions.

    e. T.T:
    TT is abbreviation of Telegraphic Transfer. All T.T advices are allotted with their on specific serial No. against which T.T is entered. Testedmessages exist for T.T advices. These messages are called as “Outward Test” for T.T issuing branch and “Inward Test” for T.T receiving branch. Only head office of the concerned bank or organization has authority to print such test messages. This method of transferring funds is considered as safest and effective way.

    Merits of Credit Money:

    1. Before credit money a lot of income and effort was spent on the production of coins, also a lot of metal was needed, so it was very expensive. Credit money has solved this problem.
    2. Circulation of credit money makes trade very easy. Before that transfer of payments and getting loan was very difficult and time consuming.
    3. Due to credit money, business become very easy and businessmen expand their business without hesitating.
    4. With the help of foreign bills international trade has also been extended and trade is possible in no time.
    5. Credit money encourages the saving habit of people so that they can invest their money in any business in future.
    6. Due to credit money government has also the facility of getting money from the banks quickly otherwise, it was very difficult in coin age.
    7. Prices of the commodities are affected by the supply of money. Due to credit money central bank is able to control the prices in the market.

    Demerits of Credit Money:

    1. Owing to credit money, government sometimes print excess of currency notes without anyguarantee to meet emergency needs, which can cause inflation in the market.
    2. As getting loan become easy, sometimes incompetent traders start their own business and face loss due to unawareness.
    3. Due to easy excess of the credit money, people get money and spend it on luxuries and face difficulties to pay back the money.
    4. Owing to credit money, big businessman can get large amount of loan easily and are able to create monopoly in the market.

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