Chapter 3 MONEY

TOPIC 1: MEANING AND DEFINITION OF MONEY:

Meaning: “Anything that is generally acceptable as a means of exchange and that at the
same time acts as a measures and as a store of value.”

Function of money

Primary function Secondary function Other function

Medium of Measure of Standard Store of Transfer of

exchange value deferred value value
payments

(A) Primary function or original function

These are those function which are common to all countries during all time periods.
Following are the two main or primary functions of money:
(1)Money is “medium of exchange”
A person can sell his goods and services in exchange for money and can use this
money for buying the goods and services that he needs.
The difficulty of the lack of double coincidence of wants has been removed.
Money becomes the representative of general purchasing power or money is generally
acceptable, everyone accepts it in exchange for goods and services and unitizes it for
purchasing articles.

(2)Money is “measure of value or unit of account”

Money measures the value of economics goods.
When we express the value of a commodity in terms of money, it is called price and by
knowing the price of various commodities, it is easy to calculate exchange ratio between
them.
Money is a useful measuring rod, value of goods & services are measured & expressed.
All records are kept and maintained in terms of monetary unit.
(B) Secondary function - These are supplementary to the primary functions.
(1)Standard for deferred payments
Those payments which are made in future. It has made possible the creation of banking
system.
Problem of absence of financial institution in the barter system. Because
Money is accepted as a standard for deferred payments because -
(a) Its value remains stable .
(b) It has the quality of general acceptability
(c) It is more durable compared to other commodities
Now both borrowing as well as lending, are done in terms of money.
(2)Store of value
It is acceptable at any point of time. It is not perishable so it can be used for future use.

Page | 1
 Chapter 3 MONEY
Shifting of purchasing power form the present to future to save a part of income.
Significance: (a) available in fractional denominations (b) easily portable (c) serve as
medium of exchange at all times.
(3)Transfer of value
Transfer values from one person to another and from one place to another.

(C) Contingent function (other function)

(1) Basis of credit creation:- like cheque, draft, etc…
(2) Distribution of national income:- national income can be distributed as rent, wages,
interest, profits etc.
(3) Maximum satisfaction of the consumer:- a consumer buys goods and services in such
a way that the price of each commodity is equal to marginal utility.
(4) Increase in liquidity of capital:- money can easily be converted into goods and
assets.
(5) Maximum profit to the producers:- if he employs the various factor of production that
the price of one unit of a factor is equal to marginal product of that factor.

TOPIC 2 SUPPLY OF MONEY:

Meaning: Money supply refer to total quantity or stock of money available in the economy
AT PARTICLAR POINT OF TIME.(hence, it is a stock concept).

(A) Currency held by the public(c) - Currency held by public or commercial bank
is high powered money or reserve money or
(1)Coins- The metallic coins are issued by CG.
monetary base.
Their face value is more than their intrinsic
value.
Currency notes & coins are
(2)Paper currency- RBI in every country has the monopoly legal tenders (called fiat
money) & they do not have
right of issuing notes.
instrinsic value.
(B) Net demand deposit held by the commercial bank(DD)
DD are deposits which can be withdrawn on demand by depositors from banks.(CASA)
Demand deposits are created by the commercial banks and are called ‘bank money.
Net shows, only the deposits of public are included (inter bank deposits are not included)

Time deposits are also held by the banks which have a fixed period of maturity.

Cheques drawn on savings or current accounts, can be refused by anyone as

Measures of money supply-
a mode of payment. Hence, demand deposits are not legal tenders while
M1 = C + DD + OD currency notes & coins cannot be refused by any citizen.

C = currency held by the public (coin and paper notes) refer (a)
DD = demand deposits of the people in commercial banks.
OD = other deposits (with RBI) of international institutions like IMF, World Bank and
Govt. institution like NABARD.

Demand deposits of Demand deposits of Demand deposits of

IMF with RBI world bank with RBI Govt. institutions

Page | 2
 Chapter 3 MONEY
There are four measures of money supply which are - M1, M2, M3, M4
M1(most liquid) & M2 are narrow money, M3 & M4(least liquid) are broad money.
M3 is most commonly used measure of money supply called aggregate monetary resources

TOPIC 3: BARTER EXCHANGE:

Meaning: direct exchange of a commodity against another commodity without the use
of money is called barter exchange.

C.C Economy :- An economy based on barter exchange or an economy based on

commodity for commodity exchange is called C.C economy.

(A) Difficulties or drawbacks of barter exchange(system)

(1) Lack of double coincidence of wants
What one person wants to sell and buy must coincide with what some other person
wants to buy and sell.
(2) Lack of standard for deferred payments
Future payment and credit transaction were not possible. Borrowing and lending were
difficult problem under the barter system.
(3) Lack of common measure of value
It is difficult to decide, in what proportion or ratio two goods are to be exchanged when
thousands of commodity are produced and exchanged.
(4) Difficulty of store and transfer of wealth -
It is difficult for the people to store wealth for future use in the form of goods & services.
(5) Lack of divisibility -
There are many goods which are not divisible.

TOPIC 4: CLASSIFICATION OF MONEY (FOR REFERENCE)

Commodity money or full bodied money- made of metal & its intrinsic
value =commodity value.

Representative money – money in circulation printed or digital backed by a

commodity that has little or no value of its own.

Legal tender money – officially issued money by RBI or CG and used as a

medium of exchange & has legal sanction behind it.

Fiat Money - It is declared as legal tender by the govt. but has no intrinsic
value and not backed by gold ,silver, etc.

Near money or quasi – money are non-cash assets that are highly liquid &
easily converted into cash. Ex – bonds, debentures.

Page | 3
 Chapter 3 MONEY

TOPIC 5: EVOLUTION OF MONEY (FOR REFERENCE)

(A) Commodity money –
In earlier times, any commodity that was generally demanded and chosen was used as
as money i.e. barter system (goods were exchanged for goods)
(B) Metallic money -
Metals like gold, silver, copper, etc are used as they could be easily handled & can be
divided into monetary units (but they are limited in supply)
(C ) Paper money –
It is regulated and controlled by RBI which mainly includes currency notes & coins
made of copper, bronze, etc.
(D) Bank money or credit money –
With the increase in number or transactions, credit money increases in the form of
cheques, drafts.
(E) Plastic money –
i.e in the form of debit cards, credit cards are most popularly used now.

TOPIC 6 -DEMAND & SUPPLY FOR MONEY

Money is the most liquid of all assets in the sense that it is universally acceptable & can
be exchanged. While deciding on how much money to hold at a certain point of time one
has to consider the trade off between the advantage of liquidity & the disadvantage of
the foregone interest. Demand for money balance is often referred to as liquidity
preference. People desire to hold money balance broadly from two motives.

Transaction motive - The principal motive for holding money is to carry out transactions
transaction demand for money of the economy is again a fraction of the total volume of
transactions in economy over the unit period of time. The number of times a unit of
money changes hands during the unit period is called the velocity of money circulation.

Speculative motive - An individual may hold her wealth in the form of landed property,
bullion, bonds, money etc. For simplicity, let us club all forms of assets other than money
together into a single category called ‘bonds’.

Bonds are papers bearing the promise of a future stream of monetary returns over a
certain period of time. These papers are issued by governments or firms for borrowing
money from the public.
ex- Face value of bond is Rs.100 & bank is paying interest @ 5% on saving A/c.
Year Coupon amount(10% interest rate) Amt.received at the time of redemption
1 Rs.10 Rs.110
2 Rs.10 Rs.120
3 Rs.10 Rs.130
4 Rs.10 Rs.140

Page | 4
 Chapter 3 MONEY

Bond is more attractive than the savings bank A/c & people will rush to hold the bond.
If you are a bond holder a decrease in bond price means a loss to you & Such a loss
occurring from a falling bond price is called capital loss to the bond holder.
you will try to sell your bond and hold money instead. Thus speculations regarding
future movements in interest rate and bond prices give rise to the speculative
demand for money.

Hence speculative demand for money is inversely related to the rate of interest.

Note -Total demand for money in an economy is, therefore, composed of transaction
demand & speculative demand. The former is directly proportional to real GDP and price
level, whereas the latter is inversely related to the market rate of interest.

Page | 5
 Chapter 3 MONEY

Page | 6
 Chapter 3 MONEY

Page | 7
 Chapter 3 MONEY

Page | 8
 Chapter 3 MONEY

Page | 9
 Chapter 3 MONEY

P a g e | 10
 Chapter 3 MONEY

P a g e | 11
 Chapter 3 MONEY

P a g e | 12
 Chapter 3 MONEY

P a g e | 13
 Chapter 3 MONEY

P a g e | 14
 Chapter 3 MONEY

P a g e | 15
 Chapter 3 MONEY

P a g e | 16
 Chapter 3 MONEY

P a g e | 17
 Chapter 3 MONEY

P a g e | 18
 Chapter 3 MONEY

P a g e | 19
 Chapter 3 MONEY

P a g e | 20
 Chapter 3 MONEY

P a g e | 21
 Chapter 3 MONEY

P a g e | 22
 Chapter 3 MONEY

P a g e | 23
 Chapter 3 MONEY

P a g e | 24
 Chapter 3 MONEY

P a g e | 25
 Chapter 3 MONEY

P a g e | 26