Function of Money
Money performs a variety of functions. Its importance and use can be fully understood if we analyse the function of money. For the sake of convenience, various function of money can be broadly divided into three main headings, viz. (A) Primary functions, (B) Secondary function, and (C) Contingent functions.
Primary Functions
The fundamental functions of money are called the primary functions. From the date of its invention, money has been performing these functions. Therefore they are known as the most original functions of money. These functions are:- money acts as a medium of exchange and as a measure of value.
1. Medium of exchange
Money acts as a medium of exchange of goods and services. This function removed the difficulty of double coincidence of wants found in the barter system. For example, the corn producing farmer was facing a great difficulty in exchanging his corn for fish or cloth. Much time and energy were wasted in searching a person who was prepared to accept the corn and to give the thing the farmer wanted. But with the invention of money, a farmer need not go from door to door. He simply sells his corn for money in the market and can purchase fish or cloth with money. Here goods are exchanged for goods but through the medium of money. Now money is acting as an intermediary between buyers and sellers to mediate exchanges.
2. Measure of value
Another original function of money is that it acts as a measure of value. In barter system, there was no common measure of value. Hence it was very difficult to remember the rates of exchange of so many goods and services. But, in modern times money has been accepted as measuring rod to measure the value of all goods and services. As we measure the length with metre, weight in gram and kilogram, time in hour, day or month, similarly to measure the value of any commodity, money acts as the measuring rod. When the value of goods and services are expressed in terms of money, we call it price. When we exchange a good for money in the market, this helps us to know the price of the good. Similarly by knowing the prices of different goods, we can easily know their rates of exchange. For example, if the price of pen is $10 and that of a pencil is $2, then the rate of exchange between pen & pencil is automatically determine. Here 5 pencils will be exchanged for one pen.
Secondary Functions of Money
In addition to the primary functions, money performs the following secondary functions.
3. Standard of deterred payments
As a medium of exchange, money facilitates current transaction of goods and services. But when we purchase a good and not pay in terms of cash but promise to pay in future, we call it deterred payments or credit transaction. If the contract for deferred payments is made in terms of goods, then one party may be loser while the other party may be gainer. For example when a person borrows paddy during, the harvest time and repays the same in times of scarcity, then the borrower will lose and the lender-landlord will gain. This is because the value of equal quantity of paddy is higher in times of scarcity (rainy season) than in harvest season. But the value of money is more stable in comparison to other goods. Hence borrowing, lending are carried out in terms of money.
If the value of money does not remain stable, then money will fail as a standard for deferred payments. If the value of money falls due to the rise in the price level. then creditors lose and debtors as a class gain. If there is deflation and the value of money rises, then creditors gain, debtors lose. Thus frequent changes in the value of money will lead to the failure of money as a standard of deferred payments.
4. Store of Value
Money acts as a good store of value. Future is uncertain and unpredictable. To meet the uncertainty of future, every individual, household and firm save a part of their current income. Absence of a good of value was a serious defect of the barter system. When saving is done in terms of goods, the quality of goods deteriorates and value of goods may change. There is danger of theft and fire. The secrecy of wealth can not be maintained as paper money has several advantages. The secrecy of wealth can be maintained as paper money does not require much space to be stored. The value of money remains stable. As a result the savers do not lose. Since money represents general purchasing power and is the most liquid of all assets, it can be converted into any goods and services at any time without any difficulty. Since banking is closely connected with money economy, there is no danger of theft and fire if money is saved in the bank. Due to these reasons money acts as a good store of value.
5. Transfer of Value
Money is the effective means through which transfer of value from one place to another can be effected. Money is acceptable everywhere and to all. Again money is portable which means it can be easily transported from one place to the other. In barter system it was very difficult and expensive to carry goods or animals from one place to the other. With the invention of money. this difficulty has been removed. Now we can sell land, building and other goods in one place for money and carry the same to any distant place. Similarly through cheque and bank draft we can send wealth or value in the from of money to any place easily and without much cost. Therefore money is regarded as a better means of transferring purchasing power from one place to the other.
Contingent Function of Money
In addition to the above primary and secondary function money performs a large number of contingent functions in modern economy. These functions are called contingent because money was not originally invented to perform these functions. But in course of time as society developed and became more complex, certain additional function were performed by money. Below we discuss these functions.
6.Basis of price Mechanism
Paul Einzig out that money acts as the basis of effective working of the price mechanism. Price mechanism refers to a process which brings equality between demand and supply in the market. The money value of a good (price) works as the barometer to indicate whether demand falls short of supply or supply falls short of demand. Ultimately the equilibrium between the forces of demand and supply is brought about through the effective working of price mechanism.
7. Distribution of National Income
National income is the result of combined effort of land, labour, capital and organisation in the process of production. From the total product the owners of factors of production get their share in the form of money. The landlords receive rent, the labourers receive wages, the capitalists get interest and the organizers get profit. Without money, the distribution of national income among various factors of production would have been a difficult task.
8. Basis of the credit system
Modern industrial and commercial activities are heavily dependent on easy and timely flow of credit. Generally banks advance credit on the basis of their cash deposits. Higher the cash deposits higher are the credit created and advanced to finance trade, commerce and industry and vice versa. If money supply decreases, deposits in the banks will fall leading to the fall in the credit creation. Thus money is the foundation on which the entire credit system stands.
