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Learning Objectives

1. Describe the properties of money.

2. Describe the functions of money.

3. Explain the definitions of money used today.

4. Explain the concept of near monies.

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Money

Money has existed for a long time, and a wide range of commodities have served as money in different countries and at different times.

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Examples of money

Throughout history, a wide variety of items have served as money. These include salt, shells, gold, silver, large stone wheels, tobacco, beer, dog teeth, porpoise teeth, elephant tusks, cattle, metal coins, paper bills and cheques.

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Money

All of these types of money should be judged on how well they accomplish the functions of money.

‘Money is what money does’.

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The barter system

Before money, economies used barter system.

The principal problem with a barter system is the double coincidence of wants required for success.

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Double coincidence of wants

Double coincidence of wants means that you must find someone who wants what you want to trade and has what you want.

This search could be extremely time-consuming and limiting to the development of an economy.

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The functions of money

The functions of money are to serve as:

(a) a medium of exchange,

(b) a standard of value and

(c) a store of value.

(d) a standard for deferred payment

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A. Medium of exchange

To be a good medium of exchange-, money must be:

1. Accepted

2. Portable

3. Divisible,

4. Durable, and

5. uniform

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Accepted

Money must be accepted by people when they buy and sell goods and services.

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Portable

It should be portable or easily carried from place to place.

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Divisible

It must also be divisible so that large and small transactions can be made.

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Durable

To function as money an asset must be durable. During its working life any unit of currency changes hands many times and an asset which deteriorated quickly would not be acceptable in settlement of a debt.

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Uniform

It must also be uniform so that a particular unit such as a quarter represents the same value as every other quarter.

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B. Standard of Value

To be a good standard of value, or unit of account, money must be useful for quoting prices. To accomplish this, money must be familiar, divisible and accepted.

This can also be expressed as ‘a unit of account’.

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C. Store of value

To be a good store of value, money must be durable so it can be kept for future use. It also should have a stable value so people do not lose purchasing power if they use the money at a later time.

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A Standard for deferred payment

In the modern world, goods are often purchased on credit, with the amount to be repaid being fixed in money terms.

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Money defined

Money is any item or commodity that is generally accepted in payment for goods and services or in repayment of debts, and serves as an asset to its holder.

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Liquidity

One term frequently used in connection with money is liquidity. An asset is more liquid the more swiftly and less costly it can be converted into the means of payment. It follows that money is the most liquid asset of all.

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Forms of money

In modern economies money takes two forms: cash (i.e. notes and coin) and bank deposits. There are several kinds of bank deposit with varying degrees of liquidity.

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Examples of bank deposits

• Sight deposits are immediately spendable.

• Time deposits can only be withdrawn after a period of notice has been given to the institution holding the deposit.

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Bank Deposits vs Cheques

Care must be taken to distinguish between the role of the bank deposits and the role of the cheques.

Cheques are simply the means of transferring a bank deposit from one person to another.

It is the bank deposit which is accepted in settlement of a debt, not the cheque. A cheque that cannot be honoured against a bank deposit is worthless.

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Bank deposits

Creating bank deposits increases the money supply

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What are bank deposits and how are they created?

Bank deposits come into being in one of three ways:

• when a bank receives a deposit of cash

• when a bank buys a security

• when a bank makes a loan

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Bank Deposits

Whichever way bank deposits are created, a bank must always ensure that its liabilities and assets are equal.

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Bank Deposits – Liabilities

Deposits are the liabilities of a bank, since they are bound to honour alt demands for cash from individual depositors up to the full amount deposited in each individual's account. In other words, deposits are claims against a bank. The assets which banks hold, however, can take a variety of forms, but they always give the bank a claim against someone else. Notes and coin, for example, give commercial banks a claim against the central bank (the Bank of England in the UK) whereas securities and advances give the bank a claim against the borrower.

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Money : Exercise 1

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Exercise 1: Functions of money

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Exercise 2

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The Functions of Money

End of Lesson