Money: Origin, Functions, Supply

  • Post last modified:28/04/2022
  • Reading time:12 mins read

What is Money?

The word ‘money’ is derived from the Latin word ‘Moneta’ which was the surname of the Roman Goddess of Juno. Money was coined in her Temple in Rome. Money is defined as anything that is generally accepted as a means of exchange and that at the same time acts as a measure and as a store of value. Money has three important functions i.e medium of exchange, a standard value and a store value.

Origin of Money

The Barter System as described above is not prevalent now. People pay only money to buy goods and services. Hence, the question arises – ‘Why did the need for money arise?’ The answer to this question lies in the fact that the barter system had many demerits, and to overcome these demerits, money as a medium of exchange evolved gradually.

The development of money as a unit of exchange has passed through various stages with respect to time, place and circumstances with the progress of economic civilizations of humankind. Economists have recognized the following stages in the evolution of money. These are the types of money:

  1. Animal Money
  2. Commodity Money
  3. Metallic Money
  4. Paper Money
  5. Credit Money
  6. Plastic Money

Animal Money

In the primary stage of civilization, domestic animals were used as money. Different goods were valued in terms of the number of cattle one can give in exchange. In the 4th century B.C., the Roman state-recognized cows and sheep as money to collect fines and taxes.

However, such a medium of exchange posed many problems: This medium of exchange was not divisible. Further, one could not store cattle for long because much space is required to store cattle.

Commodity Money

Over time, relatively durable commodities came to be used as money, including small stones, pebbles from the seashore, rare feathers, tobacco etc., for transactions. The particular commodity chosen to serve as money depended upon various factors such as the location of the community, the climatic environment of the region, and cultural and economic standard of the society.

Metallic Money

With the progress of human civilization, metallic money was preferred to commodity money. Metals such as gold, silver, and copper, were used because they could be easily handled and their quantity can be easily ascertained. It was the main form of money used throughout the major part of the world.

Paper Money

In the 17th and 18th centuries, paper currency emerged as “token money”. In the modern era, paper money has become popular. It was originally used as paper receipts against metallic money, which was found unsafe to carry by merchants. Later, due to the shortage of metals, state authorities introduced paper currency, representative paper money that was convertible.

Credit Money

Credit money and paper money emerged simultaneously. People keep a part of their cash as deposits in banks, which they could withdraw at their convenience through cheques. The cheque itself is not money, but it performs the same functions as money does.

Plastic Money

Credit cards and Debit cards are the latest types of money. They aim at removing the need for carrying cash to make transactions.

Functions of Money in Economics

Money is vital to the operation of the national and international economy. Money plays an important role in people’s daily lives, whether they are consumers, producers, business people, academicians, politicians or administrators.

The functions of money in economics can be divided into:

  1. Primary Functions
  2. Secondary Functions

Primary Functions

Primary Functions include the most important functions of money, which it must perform in every country. Money performs the following primary functions in an economy:

  1. Medium of Exchange
  2. Unit of Value

Medium of Exchange

Money serves as a medium of exchange in all transactions. Everything can be exchanged for money and money can be exchanged for anything. The currency today is generally called legal tender, that is, it has to be accepted as payment for any service or product. This function has removed the major difficulty of lack of double coincidence of wants and inconveniences associated with the barter system.

Unit of Value

Money measures the value of various goods and services which are produced in an economy. In other words, money works as a unit of value or standard of value. In a barter economy, it was very difficult to decide how much volume of goods should be given in exchange for a given quantity of a commodity.

Money, by performing the function of a common measure of value, has saved society from this difficulty. Now the value of various goods and services are expressed in terms of money such as Rs. 10 per metre, Rs. 8/- per kilogram etc. In this way, money works as the common measure of value by expressing the exchange value of all goods and services in money in the exchange market. By working as a unit of value, money has facilitated modern business and trade.

Secondary Functions

These refer to those functions of money which are supplementary to the primary functions. These functions are derived from primary functions and, therefore, are also known as ‘derivative functions’. The major secondary functions are:

  1. Standard of Deferred Payments
  2. Store of Value

Standard of Deferred Payments

Modem economic setup is based on credit and credit is paid in the form of money only. In reality, the significance of credit has increased so much that it will not be improper to call it the foundation stone of modem economic progress.

Money, besides being the basis of current transactions, is also the basis of deferred payments. Only money is such a commodity in whose form accounts of deferred payments can be maintained in such a way so that both creditors and debtors do not stand to lose.

Store of Value

It was virtually impossible to store surplus value under a barter economy; the discovery of money has removed this difficulty. With the help of money, people can store surplus purchasing power and use it whenever they want.

Saving money is not only secure but its possibility of being destroyed is very less. Besides, it can be used whenever need be. By facilitating the accumulation of money, money has become the only basis for promoting capital formation and modern production techniques and corporate business facilitated therefrom.

Money Supply

The entire quantity of bills, coins, loans, credit and other liquid instruments in a country’s economy is the money supply. The money supply is divided into multiple categories – M0, M1, M2 and M3, based on the type and size of the account in which the instrument is kept. The money supply is important to economists, who aim to understand how policies affect interest rates and growth.

Different Measures of Money Supply

  1. M0: This is a measure of the money supply that combines any liquid or cash assets held within a central bank and the amount of physical currency circulating in the economy. This measure is known as narrow money because it is the smallest measure of the money supply.

  2. M1: This is a category of money supply that includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts. The M1 is a very liquid measure of the money supply because it contains cash and assets that can quickly be converted to currency.

  3. M2: This is a category within the money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M2 is a broader classification of money than M1 is. Economists use M2 for quantifying the amount of money in circulation and trying to explain different economic monetary conditions.

  4. M3: This category of the money supply includes M2 and all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. This is the broadest measure of money; it is used by economists to estimate the entire supply of money within an economy.

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