MONEY

Exchange means act of give and take. There are two types of exchanges

1. BARTER EXCHANGE: Direct exchange of goods for goods is known as barter exchange.
An economy based on barter exchange is known as C.C economy i.e., commodity for
commodity exchange economy.

2. MONETARY EXCHANGE: Monetary Exchange is the act of exchanging goods and

services for money.

KINDS OF MONEY:

Category Types Examples

By Form Metallic Money Coins made of gold, silver, copper

Paper Money Currency notes issued by RBI

Plastic Money Debit cards, credit cards

By Issuer Fiat Money Notes and coins issued by government/RBI

Bank Money (Credit Money) Cheques, demand drafts, online transfers

Notes and coins that must be accepted by

By Legal Status Legal Tender Money
law

Non-Legal Tender (Optional Cheques, promissory notes (accepted by

Money) choice)

By Backing Full-bodied Money Value of metal = face value (e.g., gold coin)

Face value > intrinsic value (modern coins,

Token Money
notes)

By Modern
Electronic/Digital Money Mobile wallets, UPI, crypto
Usage

EXPLANATION :

Money is most useful and necessary invention. It has undergone a long process of evolution:

1. Commodity money: Human beings exchanged goods for goods called barter exchange.
All sorts of commodities like seashell, tobacco, cow, leather, pearls precious stones, salts
etc. have been used as a medium of exchange. They were called commodity money.

The use of commodity as money had the following defects:

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 [Link] commodities were not uniform in quality Thus lack of standardization made pricing
difficult.

2. Difficult to store and prevent loss of value in the case of perishable commodities.

3. They lacked in portability and hence were difficult to transfer from one place to another.

4. There was the problem of indivisibility in case of commodities such as cattle.

[Link] money: Up to first half of the 18th century, the medium of exchange were
metals, particular gold and silver, copper, nickel etc. Metallic money is further classified
into standard money, token money and subsidiary money.

(i) STANDARD MONEY: Standard money is that whose face value is equal to
their intrinsic value. Holder of such coins may use them as metal by melting
them or as money, because the value of the metal in the coins is the same
as their monetary value. Standard money is therefore known as full bodied
money.

(ii) TOKEN MONEY: Token money is representative money whose intrinsic

value of the metal is less than its face value. The rupee coin in circulation in
India is a token coin.

(iii) SUBSIDIARY MONEY: Subsidiary money is to assist the token money. All
coins of the denominations from 5paise to 25 paisa in India are subsidiary
money. Such coins are limited legal tenders in which payments can be done
only up to Rs. 25 in India.

Gold and Silver found prominence for the following reasons:

(a) Gold and Silver were widely accepted as a medium of exchange.

(b) They were limited in supply

(c) They were durable (nearly nonperishable)

(d) Gold and silver could easily be divided into small monetary units.

But after 1930’s use of metallic money as a medium of exchange was discarded because.

(a) The world’s production of gold and silver was not enough to match the
requirements of increasing volume of internal and external trade

(b) Metallic money was inconvenient to handle, safety during transportation was
also a big problem

(c) Being heavy it was not possible to carry a large sum of money in the form of
coins from one place to another

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3. PAPER MONEY: From 1930’s onward most countries are using paper currency as a prominent,
and nearly exclusive medium of exchange. Paper money can be classified into the following
types.

1 REPRESENTATIVE PAPER MONEY: It is also known as representative full-bodied money

because it is fully backed by gold coins or gold bullion held by the treasury.

2. CONVERTIBLE PAPER MONEY: Convertible paper money is that which does not have 100 per
cent backing in the form of standard coins or bullion. But the holder of paper money can get it
converted into bullion or coins on demand.

5. INCONVERTIBLE PAPER MONEY: The paper money which does not have any backing of
standard coins or bullion and is also not convertible into them is known as inconvertible
paper money. Notes issued by central banks of all countries represent inconvertible
paper money. They are also known as fiduciary money.

6. FIAT MONEY: Fiat money is a type of money widely accepted all over the world. Fiat
money has no intrinsic value but having value for making transactions which promised
by government or currency issuing authority. It is the existing type of money in the
world. Fiat money is a legal tender.

Money which the state and people accept as the means of

payment and for discharge of debts is known as legal tender. All notes and coins issued
by the govt. and the central bank of a country are compulsorily a legal tender in that
country. It can be further divided into two parts:

1. Limited legal tender: It is a type of money through which payments can be made
legally up to a certain limit only. all coins of the denominations of 5 paisa to 50 paisa
are limited legal tender in India. Payments in them can be made up to a limit of Rs.
50 only.

2. Unlimited legal tender: A money is unlimited legal tender when payments can be
made in it in unlimited amount. All paper notes and coins above 50 paise and 1
Rupee are unlimited legal tender in India.

7. CREDIT MONEY / BANK MONEY: It refers to the deposits in the bank. Credit money or
bank money is transferred by a commercial bank in the form of cheque or draft. But a
cheque or draft is not money. Demand deposits in a bank is money which is withdraw
able by a holder of the deposit through cheque or draft. Thus, it is demand deposit
which is credit or bank money that is transferable from one person to another through
cheque or draft, but a cheque or draft is not legal tender and may not be accepted as a
medium of exchange or means of payment.

8. Near money: Deposit money, bonds, securities, debentures, bills of exchange, treasury
bills, insurance policies etc. are known as near money.

9. Plastic money: All kind of cards like credit and debit cards are known as plastic money.

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 MONEY MEANING AND ITS FUNCTIONS

MEANING OF MONEY: According to Walker “Money is what money does”

According to Seligman “Money is one thing that possess general acceptability”

According to Cole “Money is anything that is habitually and widely used as a means of
payment and its generally acceptable in the settlement of debts”

FUNCTIONS OF MONEY: “Money is a matter of functions four

a Medium, a measure, a standard, and a store.”

[Link] FUNCTIONS: The two primary functions of money are to act as a medium of
exchange and a measure of value.

(a) MEDIUM OF EXCHANGE: This is the central function of money. For performing this
function, money should have general acceptability. Money as a medium of exchange divides
the exchange transactions into two parts namely sale and purchase. This function of money
removes the double coincidence of wants. for buying and selling. Medium of exchange
simply refers using money

(b) MEASURE OF VALUE: Money serves as a unit of account. It measures the value of
economic goods. Money works as a common denominator into which the values of all goods
and services are expressed. When we express the value of a commodity in terms of money is
known as price

[Link] FUNCTIONS:

(a) STORE OF VALUE: Wealth can be stored in the form of money. Money can be stored
without loss in value. Savings are secured and can be used whenever there is need. In this
way, money acts as a bridge between the present and the future.

(b) STANDARD OF DEFERRED PAYMENT: Credit has become the life and blood of a modern
capitalist economy. In millions of transactions instant payments are not made. The debtors
make a promise that they will make payment on some future date. It has become possible
because money has general acceptability its value is stable it is durable and homogeneous.

TRANSFER OF VALUE: Value of any asset can be transferred from one person to another
person or to any institution or to any place by transferring money. The transfer of money
take place irrespective of places time and circumstances. Transfer of purchasing power,
which is necessary in commerce and other transactions, has become available because of
money.

3 CONTINGENT FUNCTIONS

(I)BASIS OF CREDIT: Business transactions are either in cash or in credit, credit economizes
the use of money. But money is at the back of all credit. A commercial bank cannot create
credit without having sufficient money in reserve.

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 (II) BASIS OF DISTRIBUTION OF INCOME: Money facilitates the distribution of income
among people. Total output of the country is jointly produced by several workers, landowners’
capitalists, and entrepreneurs so this will be distributed among them. Money helps in the
distribution of national product through the system of wage, rent, interest and profit.

IIIc Maximization of satisfaction: Money helps consumers and producers to maximize their
benefits. A consumer maximizes his satisfaction by equating the prices of each commodity with
its marginal utility. Similarly, a producer maximizes his profit by equating the marginal
productivity of a factor unit to its price.

(iv) LIQUIDITY: It is again through money transaction that immovable property

can be changed into liquid form. Money helps to bring about liquidity and
uniformity of wealth.

(v) BEST UTILISATION OF RESOURCES: Money helps in utilizing all the resources
to the fullest.

MONEY SUPPLY MEANING AND ITS MEASURES

Meaning of money supply: The supply of money means the total stock of all the forms of money
supply (paper money, coins, and bank deposits) which are held by the public at any point of
time. Two points need to be noted in this connection: (i) Supply of money is a stock variable
because it is related to a point of time (ii) Stock of money always refers to the stock of money
held by the public which is always smaller than the total stock of money in existence Here the
term public includes all economic units like households, firms, local administration, on banking
financial institutions etc. except producers of money. And the producers of money are Central
government, RBI, and all the banks which accept demand deposits.

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MEASURES OF MONEY SUPPLY (MONEY STOCK) In India RBI uses four alternative measures of
money supply called MI, M2, M3 and M4.

(I) M1 = C +DD+OD where

C= Currency held by public

DD = Net demand deposits of the bank

OD = Other deposits held with the RBI. These are the deposits of quasi government institutions
like Industrial development Bank of India, IMF, World Bank etc. with RBI.

M1 is a narrow definition of money.M1 is most liquid and easiest for transactions.

(II) M2 = MI+ Saving deposits with post office saving banks.

M2 is also narrow money but broader than M1. In addition to M1it also includes
saving deposits with post office saving bank.

(iii) M3: M3 is broad money. It is most used measure of money supply.

M3 = M1 + Net time deposits with the commercial banks.

(III) M4: M4 money supply is still broader. It is broader than M3

M4= M3 + Savings with post Offices (other than in the form of National saving
certificates)

Important facts about measures of money supply.

[Link] four measures of money supply represent different degrees of liquidity, with
M1 being most liquid and M4 being the least liquid

2. M3 is widely used as a measure of money supply, and it is known as aggregate

monetary resources of the society.

3.M1 and M2 are generally known as narrow money supply concepts, whereas M3
and M4 are known as broad money supply c

High Powered Money: High Powered money refers to the total liability of the
monetary authority of the country. It consists of:

(i) Currency held by the public.

(ii) Cash reserves with commercial banks.
(iii) Required reserve of the commercial banks to be maintained with RBI; and
(iv) Other deposits with the RBI.
The high-powered money is also called as the Monetary Base or the
Reserve Money of the country.

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The difference between money and high-powered money lies in the fact that money consists of
currency and demand deposits while High powered money consists of currency and cash
reserves with banks.

INFLATION

 Meaning: Inflation is the sustained rise in the general price level of goods and
services in an economy over a period of time.
 Effect: When inflation occurs, the purchasing power of money falls, i.e., you
can buy fewer goods with the same amount of money.

Example: If last year 1 litre of milk cost ₹50 and this year it costs ₹55, that’s inflation.

DEMAND PULL INFLATION

This is when the aggregate demand in an economy exceeds the aggregate supply. This increase in
the aggregate demand might occur due to an increase in the money supply or income or the level
of public expenditure.

This concept is associated with full employment when altering the supply is not possible. Take a
look at the graph below:

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In the graph above, SS is the aggregate supply curve and DD is the aggregate demand curve.
Further,

 Op is the equilibrium price

 Oq is the equilibrium output

Exogenous causes shift the demand curve to the right to D1D1. Therefore, at the current price (Op),
the demand increases by qq2. However, the supply is Oq.

Hence, the excess demand for qq2 puts pressure on the price, increasing it to Op1. Therefore, there
is a new equilibrium at this price, where demand equals supply. As you can see, the excess demand
is eliminated as follows:

 The price rises which leads to a fall in demand and a rise in supply.

COST-PUSH INFLATION

Supply can also cause inflationary pressure. If the aggregate demand remains unchanged but the
aggregate supply falls due to exogenous causes, then the price level increases. Take a look at the
graph below

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In the graph above, the equilibrium price is Op and the equilibrium output is Oq. If the aggregate
supply falls, then the supply curve SS shifts left to reach S1S1.

Now, at the price Op, the demand is Oq but the supply is Oq2 which is lesser than Oq. Therefore,
the prices are pushed high till a new equilibrium is reached at Op1.

At this point, there is no excess demand. Hence, you can see that inflation is a self-limiting
phenomenon.

OPEN INFLATION

This is the simplest form of inflation where the price level rises continuously and is visible to people.
You can see the annual rate of increase in the price level.

REPRESSED INFLATION

Let’s say that there is excess demand in an economy. Typically, this leads to an increase in price.

However, the Government can take some repressive measures like price control, rationing, etc. to
prevent the excess demand from increasing the prices.

HYPER-INFLATION

In hyperinflation, the price level increases at a rapid rate. In fact, you can expect prices to increase
every hour. Usually, this leads to the demonetization of an economy.

DEFLATION

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  Meaning: Deflation is the persistent fall in the general price level of goods and
services in an economy over a period of time.
 Effect: Purchasing power of money increases, but it usually indicates weak
demand and economic slowdown.

Example: If a car priced at ₹10 lakhs this year falls to ₹9.5 lakhs next year due to weak
demand, that’s deflation.

Basis Inflation Deflation

Sustained rise in the general
Sustained fall in the general price
Meaning price level of goods and
level of goods and services.
services.
Decreases (purchasing power
Value of Money Increases (purchasing power rises).
falls).
Consumers can buy fewer goods Consumers can buy more goods with
Consumer Effect
with the same money. the same money.
Often indicates weak demand,
Often indicates excessive
Economic Signal overproduction, or economic
demand or higher costs.
slowdown.
Excess demand (demand-pull) Decline in aggregate demand,
Causes or increase in cost of production reduced investment, fall in
(cost-push). consumption.
Moderate inflation may
Impact on encourage production and Deflation discourages production,
Growth growth; high inflation is leads to unemployment and recession.
harmful.
Favors borrowers (they repay Favors lenders (they are repaid with
Borrowers &
with cheaper money). Harms more valuable money). Harms
Lenders
lenders. borrowers.
Prices of milk rising from ₹50 Price of a car falling from ₹10 lakhs
Example
to ₹55 per litre. to ₹9.5 lakhs.

Basis
Demand-Pull Inflation
Cost-Push Inflation
Inflation caused by excess Inflation caused by an increase in
Meaning demand for goods and services cost of production of goods and
in the economy. services.
Aggregate Demand (AD) rises
Aggregate Supply (AS) falls due to
Cause faster than Aggregate Supply
higher production costs.
(AS).
• Higher consumer spending• • Rise in wages• Increase in raw
Main Factors Government expenditure• material prices• Higher fuel/energy
Investment boom• Easy credit costs• Higher indirect taxes
Effect on Output In the short run, output and Output falls because producers cut

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 Basis Inflation Deflation
employment may increase. production due to rising costs.
Graph
Rightward shift of AD curve. Leftward shift of AS curve.
Representation
Increase in crude oil prices raises
Festivals increase demand for
Example transport and production costs,
goods faster than supply.
leading to higher prices.

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