Money & Its Functions


Money is one of the most important discoveries of the human civilization. It is difficult to think about the world without money. Everybody needs money for various purposes; starting from day–to–day transactions to saving for future.

If you go back to history, you will find that before money came into existence there was barter system to facilitate transactions among individuals in the society. With development of civilization over time, barter system lost its ground and was replaced by money.

Meaning of Money

Money has been defined differently by different economists. But the most acceptable definition of money can be stated in terms of all the functions of money. Money is anything which is generally accepted as a means of exchange, a measure and store of value and which also acts as standard of deferred payments.

Functions of Money

The use of money has removed the drawbacks of barter system. Broadly speaking the functions of money may be classified into primary (basic) and secondary functions.

  • Primary or Basic Functions
    • Medium of Exchange
    • Measure of Value
  • Secondary Functions
    • Store of Value or Wealth
    • Standard of Deferred Payments
    • Transfer of Value
  • Other functions of Money
    • Distribution of National Income
    • Liquidity and Uniformity of Value

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Primary or Basic Functions

Medium of Exchange

Money acts as a medium of exchange of all goods and services. The use of money has greatly facilitated process of exchange by dividing it into two parts i.e. sale and purchase. It has removed the difficulty of double coincidence of wants found under the barter system. Therefore, in modern world we hardly find any evidence of exchange of goods and services without the use of money.

Example: You pay ₹ 10 to buy a pen. The seller receives ₹ 10 from you by selling the pen. So a pen is exchanged for ₹ 10.

Measure of Value

Money helps to measure value of goods and services in terms of price. The use of money has completely removed the confusion regarding value of one good/service vis-a-vis the other. This function has greatly facilitated the process of exchange of different goods and services. The value of a good is determined by multiplying its price with the quantity purchased. Since the price is expressed in monetary units, the value of a good is also expressed in monetary terms.

Example: Let price of rice be ₹ 20 per Kilogram. One bag full of rice weighs 25 Kilograms. Then the value of the bag of rice is ₹ (20 X 25) = ₹ 500

Secondary Functions

Store of Value or Wealth

Money is the most convenient and economical means to store wealth which does not lose its value so quickly over time. Thus, it is the most accepted means to store wealth or value.

As medium of exchange you can pay money to buy goods. This means if you have money, you have the power to purchase a good or a service. So money has purchasing power. The value of the good is contained in that purchasing power. Hence value of good is indirectly stored in money, you hold. Similarly, as a seller of good, you receive the money which means value of good you sold, comes back to you through money.

Example: Harpreet sells furniture to a buyer for ₹ 2500. This means a value of ₹ 2500 was exchanged. The buyer, who purchased the furniture, has the purchasing power to give ₹ 2500 as value. Hence a value of₹ 2500 was stored in the money received by Harpreet as a seller. Harpreet could not have stored furniture but she can definitely store money which in turn has stored the value of ₹ 2500.

Standard of Deferred Payments

Deferred payments are those payments which are promised to be made in future. Money acts as a means of deferred payments mainly because it has general acceptability. Its value remains relatively constant over time and it is more durable as compared to other goods. In case of borrowing and lending activities only money is normally acceptable to be paid at a future date. Goods loose their value over time and due to possibility of lack of double coincident of wants they are not acceptable to settle debts in future.

Transfer of Value

This function of money is derived from the store of value function of money. Money is used to transfer value from one place to another or from one person to another. As a traveller when you move from one place to another, you can easily carry money to make necessary transactions on the way and in your destination place. You can also transfer the money through bank. Now people carry ATM card and withdraw cash wherever the facility is available.

Other functions of Money

Distribution of National Income

Income is generated by the factors of production engaged in the production process. The factors are land, labour, capital and entrepreneurship. For the supply of these factor services to the production units, the supplier of labour gets wage, the supplier of land gets rent, the supplier of capital gets interest and the supplier of entrepreneurship gets profit. It should be noted that wage, rent, interest and profit are paid by the firms in money terms and received by the respective suppliers as factor incomes. Thus national income is measured by using income method.

Liquidity and Uniformity of Value

Money can be easily carried and is easily divisible into smaller units as per convenience. The liquidity feature of money is manifested at the time when it can be withdrawn from the bank account repeatedly in certain amount in each transaction. For example, your father has ₹10,000 deposited in his bank account. You want to purchase a shoe worth ₹600. Your father can withdraw the amount from the bank to give you. The balance of ₹9,400 will remain in your father’s account.

Money brings uniformity in value of different goods and services which are not comparable physically due to their differences in the units of measurement.

For example: A Kg of rice and a litre of cooking oil cannot be added together as these are given in different units. But they can be added together if expressed in monetary units. If a Kg of rice is worth ₹25 and a litre of cooking oil is worth ₹75, the combined value of rice and oil comes out to be ₹100.

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Bibliography : NIOS – Economics

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