Medium of exchange
Evolution of money
Kinds of money
Functions of Money
Difference between money and near money
Demand for money
Theories of demand for money
RATE OF INTEREST AND PRICE OF BONDS
Keynes theory of demand for money or liquidity preference theory
MONEY AND PRICES
FRIEDMAN'S...
Medium of exchange
From early days onwards man produces what is more than required. The balance after their
use was shared with others for their product. Initially commodities was exchanged for one
another. Later some common medium of exchange was emerged. Initially domestic animals
were used as a medium. Later commodities like bow, arrow, animal skin, shell, rice, tea etc.
were used. Later on gold, silver and other metals were used. During 17th and 18th century
paper money became important. Later due to the emergence of banking system bank money
became common [cheque against demand deposit]. Today the world entered into electronic
signals and devices for the people to make deposit and purchases.
Barter System
Before money came in to use exchange took place through barter system. Barter is the direct
exchange of goods for other goods without using a medium of exchange. Eg; corn may be
exchanged for horse
Advantages of barter system
1. Simple system
2. Goods are produced just to meet the need of the society, so there is no over production or
under production.
3. There is no chance for international trade problems such as BOP crisis, exchange rate
problems etc….
4. No possibility of storing of commodities. So no chance for the accumulation of wealth on
some people.
5. Personal and natural resources are ideally utilized to meet the need of the society.
6. It leads to division of labour and specialization.
Difficulties of barter system
1. Lack of double co-incidence of want:– it means under barter system the wants of two persons
who desire to exchange must co-inside. Eg; if A want to get shoes in exchange of wheat, then
he must find another person who want wheat for shoes. Such double co-incidence involve
great difficulty and wastage of time.
2. Absence of common measure of value:– value of the commodity in the market cannot be
calculated. So a problem arise ie, how much wheat should be exchanged for one pair of shoes.
3. Lack of store of value:– most of the goods lack sufficient durability. Their value deteriorate
overtime. So their commodities cannot be used for future use.
4. Lack of divisibility:- all commodities cannot be divided and sub divided. So when a big
indivisible commodity is exchanged for smaller commodity problem arises.
5. Difficulties in deferred payment:– in barter system there is no common unit which can be
used for future payment.
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6. Problem of transportation: – goods and services cannot be transported from one place to
another easily.
So barter may be relevant in economies where people have limited wants. But in modern
economy barter is not relevant.
Evolution of money
As the society developed due to division of labour and specialization in production, volume of
trade increased. In such situations direct exchange of goods [barter] created problems. Double
coincidence, divisibility, common measure, storing etc. In order to overcome these difficulties
money was invented.
The development of money to the present form historically passed through different stages in
line with human civilization.
1. Animal money:-agricultural communities commonly used domestic animals as a medium of
exchange. Different commodities are valued on the basis of number of cattles that they can
command in exchange.
2. Commodity money:- certain commodities like precious stones, bow, arrow, animal skin
shell, rice, tea etc were accepted as a medium of exchange. The selection of commodities
depended on several factors like location of commodities, climate of region, value of
commodities, durability etc. This system was mainly practiced in pastoral age.
3. Metallic money:- it was common in the commercial stage of the society. Gold and silver
were commonly used as a medium of exchange. Because of their usefulness and attractiveness
they were considered as natural money. Use of metals as money ultimately led to coinage
system.
4. Paper money :– introduced in 17th and 18th century. Due to safety problems of carrying
costly metals, merchants used to carry paper receipts against metallic money. Later due to the
shortage of metallic money authorities introduced paper money, convertible paper currency
[paper money was convertible into metals]
5. Credit money:- due to the emergence of banking institutions, bank money emerged as an
important medium of exchange. It is not money but it perform the function of money. So it is
regarded as near money. Eg; cheque issued against demand deposits.
6. Electronic banking stage:- many developed countries moved to electronic banking instead of
cash and cheque. People make deposits and purchases by using electronic equipments. It
doesn’t mean the death of money, but refer to a change in the mode of transfer.
Definition of money
• Anything accepted as payment for goods and settlement of debts.
• Many economist defined money as, ‘money is what money does’.
• In general sense money can be defined as, any commodity that is generally accepted as the
medium of exchange and measure of value.
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• Money is a set of liquid financial asset. The variations in its stock will have impact on
economic activity. – Y V Reddy Committee
• Money as those assets which are close substitute for one another-Milton Friedman of
Chicago school
• In economics, Money refers to those assets that are widely used and accepted in payment
There are two basic features of money
1. Money is the most liquid asset – liquidity means the easiness and quickness with which it can
be exchanged for goods and services.
2. Money pays low return- there is no return of holding the money.ie, relative to other assets
money earns low return. It is the cost of holding money.
Kinds of money
1. Metallic money:-Metallic coins are made of iron, copper, silver, gold, aluminium etc..It was
believed that first metallic coins were made and used in ancient Lydia during 7TH B.C. In
India it was in use 2500 years ago. Initially it was minted and introduced by private bankers
and gold smiths who certify the purity and weights. Later govt. issued coins in uniform value
and shape.
2. Paper money:-It consist of currency notes printed , authenticated and issued by the govt. and
central bank. It is the most important form of money supply.
3. Bank deposits:-Third form of common money is bank deposit. It includethree types of
deposits. They are current account deposits, saving bank deposits, and time deposits. Among
this current account deposits are available on demand. So they are known as demand deposits.
Today cheques are accepted as a means of payment. Cheque by itself is not a money. It is
only a credit instrument which perform the functions of money. So credit money is near
money.
4. Legal tender money:-It is one which is enforced by law. No one can refuse to accept it as a
means of payment. Eg; Indian currency and coins .
5. Optional money:-It is the money which may or may not be accepted as means of payment. No
legal sanction. Eg. Different credit instruments like cheque, bank draft etc..No one can force
to accept it.
6. Commodity money and representative money:- Commodity money is made of certain metals.
Its face value will be equal to intrinsic value. It serve as a medium of exchange and store of
value. Here its value is materially equal to it component.
7. Representative money is the money whose value is greater than its material. Eg; paper
currency notes.
8. Money proper and money of account:- Money proper or actual money is money which is in
circulation in the economy. It is the medium of exchange and means of payments. Eg. Indian
rupee and coins.
9. Money of account is one in which accounts are maintained. Eg; general purchasing power,
debt price of goods and services are expressed in terms of money of account.
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