Money: Definition, History, Features Functions of Good Money

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What is Money?

Money is any tangible commodity which is generally acceptable as a medium of exchange for goods and services or for purposes of settling debts within a given society/community.


Historical Development of Money

A number of commodities have served as money at different periods of history and in different communities.

(1) Commodity Money

The earliest forms of money were regarded as commodity money. They were commodities which had intrinsic value and were commonly used by people, thereby making them generally acceptable as a means of exchange.

In parts of West Africa, commodities such as cowries, shells, manillas, elephant tusks, salt, tobacco, cattle etc were used. These early forms of money did not possess most of the qualities of good money, they were not durable, not easily portable, not homogeneous, nor divisible etc.

(2) Metallic Money (coins)

Because of the problems associated with the use of commodity money, metallic money was introduced.

  • The earliest forms of metallic money (coins) were made of precious metals, especially gold and silver. They were more portable, homogeneous, divisible, durable etc. These early forms of metallic money were ‘standard coins’, that is, they contained their full face value.
  • Token Coins: Other cheap metals such as aluminum, zinc etc. were later used to replace gold and silver coins which were increasingly getting scarce. A ‘token coin’ does not contain the full face value. The market value of the coin (if melted down) is less than the face value of the coin.

(3) The Bank Notes (paper money)

The use of bank notes originated from the activities of goldsmiths who accepted deposits of gold and silver coins from merchants and issued receipts.

The merchants discovered that they could use the receipts for making transactions rather than returning them to the goldsmith to collect their deposits each time a transaction had to be made. The deposit receipt that was issued by goldsmiths became the first bank notes.

(4) Instruments of credit/near money

In the modern world, the volume of transactions has increased significantly. This, coupled with the risk of carrying cash has led to the use of other instruments such as Cheques, Postal Orders, Money Orders, Bills of Exchange, Promissory Notes, Bank Drafts, etc. in modem transactions, in addition to the use of cash.

(5) Near Money

A near money is typically a store of value, for example, a savings account, which is not itself a medium of exchange but can be turned into money very quickly and with little or no risk of loss. It has higher liquidity the more readily it can be converted to money without risk of loss.

Other forms of near money are certificates of deposits (CDs), Repurchase Agreements (RPS), Treasury Bills (TRs), Commercial papers (CPS), etc.

Features of Good Money

For any commodity to serve as a good means of exchange it must possess the following qualities.

  • General acceptability: The commodity must be generally acceptable to the members of the community as a means of making payments.
  • Portability: It must be easy to carry about for purposes of exchange.
  • Divisibility: It must be easy to divide the commodity into smaller units or denominations for small transactions.
  • Homogeneity or standardized units: Each unit of money (of a particular denomination) must be identical with other units.
  • Durability: The commodity should not deteriorate easily over time.
  • ReIative scarcity: The commodity must not be too scarce or too plenty.
  • Stability in value: The value of the commodity must not be changed frequently.
  • Easily recognizable: The commodity must be easy to identify as true money by all.

Functions of Money

Roles of money include:

  • A medium of exchange: The use of money facilitates exchange of goods and services.
  • Measure of value and unit of account: The value of goods and services are measured in monetary units. In addition, records of business transactions are kept in units of money.
  • A store of value: It is more con of money, surplus wealth or income in the form because of its durability.
  • A standard for deferred payment: The use of money can facilitates credit transactions as one can buy goods or services on credit and pay later.

The Supply of Money and the Demand for Money

(A) The supply of money

The supply of money refers to the total stock of money available for use in an economy. It consists of the following, coins, bank notes and bank deposits (current account deposits).

Money supply means the amount of money which is available in an economy in sufficiently liquid and spendable form. In practice, what constitutes components of money supply are defined by the monetary authorities in any given economy.

In this case, it is the relative liquidity of different classes of assets that will determine what qualifies for inclusion in money supply computations.

  • Major Determinant of Money Supply

(i) Monetary Base or High Powered Money (Bank Balance + Currency)

(ii) Credit creation by Banks (the Multiplier Concept)

(iii) Velocity of circulation of money.

(iv) Foreign exchange transactions.

(v) Depth of the Financial Market, especially banking habit.

(B) The Demand for Money

The demand for money refers to the desire to hold money; that is, to hold money in its liquid form rather than investing it.

There are three main motives behind the demand for money:

  • The transaction motive: People hold money for their day-to-day expenditure on food, clothing, fuel, etc. The amount of money held depends on the level of income and the interval between pay-days.
  • The precautionary motive: People hold money in liquid form to enable them meet any unforseen or emergency expenditure such as sudden sickness, death, an important unexpected visitor etc. The amount held depends on the level of income.
  • The speculative motive: This refers to the demand for money in order to take advantage of profitable investment opportunities which may arise. If the prices of bonds fall or if the interest rate is high, people would invest in bonds and hold less money. But if prices of bonds rise or if the interest rate falls, people would hold more money.

The Value of Money and the Price Level

The ‘value of money’ refers to the purchasing power of a currency; that is the quantity of goods and services which a given sum of money can buy.

If a sum of money (say $100) can now buy more goods and services than previously, the value of money has risen. On the other hand, if that sum of money can now purchase fewer commodities, the value of money has decreased.

There is an inverse relationship between the price level and the value of money. If the price level falls, the value of money would increase, because a given sum of money would purchase more goods and services.

On the other hand, if the price level increases the value of money would fall because a given sum of money would purchase fewer commodities.

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