Money | Explained

EVOLUTION OF MONEY

Money has evolved through different stages according to time, place, and circumstances. It developed through the following stages :

• Commodity Money : In the earliest period of human civilization, any commodity that was generally demanded and chosen. as money. Goods like furs, skins, salt, rice, wheat, utensils, weapons etc. were commonly used as money. Such exchange of goods for goods was known as ‘Barter Exchange’.
• Metallic Money : With progress of human civilisation, commodity money changed into metallic money. Metals like gold, silver, copper, etc. were used as they could be easily handled and their quantity can be easily ascertained.
• Paper Money : It was found inconvenient as well as dangerous to carry gold and silver coins from place to place. So, invention of paper money marked a very important stage in the development of money. Paper money is regulated and controlled by Central bank of the country (RBI in India).

• Credit Money : Emergence of credit money took place almost side by side with that of paper money. People keep a part of their cash as deposits with banks, which they can withdraw at their convenience through cheques, The cheque (known as credit money or bank money), itself, is not money, but it performs the same functions as money.
• Plastic Money : The latest type of money is plastic money in the form of Credit cards and Debit cards. They aim at removing the need for carrying cash to make transactions.

Q.What is Barter System ? State its inconviences ?

Ans. BARTER SYSTEM

It means direct exchange of goods for goods is called barter economy. In other words, an economy based on a barter system is called C: C economy i.e., a commodity for commodity exchange economy. Its main inconveniences are :

Limitations of Barter Exchange

The major limitations of Barter Exchange are:

1. Lack of Double Coincidence of Wants : Barter system can work only when both buyer and seller are ready to exchange each other’s goods. For example, A can exchange goods with B only when A has what B wants and B has what A Wants. However, such double coincidence is very rare.

Lack of Common Measure of Value :  In the barter system, all commodities are not of equal value and there is no common measure (unit) of the value of goods and services, in which exchange ratios can be expressed.

1. For example, if A has Wheat and B has rice, then it is difficult to decide, how much wheat is needed to exchange with one kilogram of

rice. In the absence of a common measure, the exchange ratio is fixed randomly, in which one of the parties generally suffers.

• Lack of Standard of Deferred Payment : Under barter system, contracts involving future payments or credit transactions cannot take place with ease because of following reasons :
  • The borrower may not be able to arrange goods of exactly same quality at the time of repayment
  • There may be conflicts regarding which specific commodity is to be used for repayment.
  • The commodity, to be repaid, may lose or gain its value at the time of repayment.

So, it is very difficult to make deferred payments in the form of goods.

• Lack of Store of Value : Under barter system it is difficult for people to store wealth for future use because:
  • Most of the goods (like wheat, rice, vegetables, etc.) do not possess durability, i.e. their quality deteriorates with passage of time.
  • Storage of goods requires time and efforts.

As a result, goods cannot be used to store the earnings for a long period

DEFINE MONEY

Money is anything that is generally accepted as a medium exchange, a measure of value, store of value, and means for the standard of deferred payment.

What is Money Supply

Money supply refers to the total volume of money held by the public at a particular point of time in an economy.

What are Features of Money Supply

1. It includes ‘money held by public only’.  The term ‘public’ signifies the money-using sector i.e. individuals and business firms.  It does not include money-creating sector, i.e. Government and banking system as cash balances held by them do not come into actual circulation in the country.
2. It is ‘Stock Concept’, i.e., it is concerned with volume of money held by public at a particular point of time.

Measures of Money Supply

But, since 1977, four alternative measures of money supply (M₁, M₂ M₃ and M₄ )have been evolved.

Measures of Money Supply

Till 1967-68, the Reserve Bank of India (RBI) used only the narrow measure of the money supply. But, since 1977, four alternative measures of money supply

(M₁, M₂, M_3, and M₄) have been evolved :

It is the first and basic measure of the money supply. It is also known as ‘transaction money’ as it can be directly used for making transactions.

M₁ = Currency and coins with Public + Demand Deposits of Commercial

Banks + Other Deposits with RBI

M₁ is the most liquid measure of the money supply as all its components are easily used as a medium of exchange.

Currency and coins with the Public: It consists of paper notes and coins held by the public. Remember, any currency held with the government and banks is not to be included.

It includes coins of denominations of ˆ 10,5,2,1, etc. and paper notes of denominations like ˆ 2,000, 500,100, etc.

Currency money is also termed as ‘Fiat Money. Fiat money is defined as the money which is under the fiat or order from the government to act as money, i.e. under law, it must be accepted for all debts.

It is also termed as ‘Legal Tender Money’ as it can be legally used to make payment of debts or other obligations.

Demand Deposits of Commercial Banks:lt refers to demand deposits of the public with the commercial banks. Demand deposits are deposits, which can be encashed by issuing cheques at any time by the account holders. A demand deposit is treated as equal to currency held as it is readily accepted as a means of payment.

Only Net Demand Deposits are included: It must be noted that demand deposits are taken on net >asis, i. e. inter-bank deposits are excluded. Inter-bank deposits are the deposits held by banks on behalf \f other banks. Such deposits do not form a part of the money supply, as they do not belong to the public. Other deposits with Reserve Bank of India (RBI):lt include deposits held by the RBI on behalf of foreign banks and governments, public financial institutions, World Bank, IMF, etc. However, it does not include deposits of the Indian Government and commercial banks with RBI.

• M₂

It is a broader concept of the money supply as compared to M1.  In addition to M1, it also includes saving deposits with the post office saving bank.

M₂  M₁ + Savings deposits with Post Office Saving Bank.

• M₃

This concept is broader as compared to M₁.  In addition to M₁, it also includes net time deposits.

M₃  M₁ Net Time Deposits with Banks

• M₄

This measure includes total deposits with the post office saving bank in addition to M₃.

M₄ = M₃ + Total Deposits with Post Office Saving Bank (Excluding NSC) NSC = National Saving Certificate.

Example of Money Supply

Calculate  M₁, M₂, M₃and M₄:

• Currency with public        84,000
• Demand deposits with banks     68,000
• Other deposits with RBI   3,612
• Total deposits with Post Office   22,500
• Time deposits with banks 2,00,555 (vi) Post Office saving bank deposit 5,528

Solution

M₁ = Currency with public + Demand deposits + Other deposits with RBI

M₁ = 84,000 + 68,000 + 3,612 = Rs. 1,55,612

M₂ = M₁ + Savings deposits with post office saving bank

M₂ = 1,55,612 + 5,528 = Rs. 1,61,140

M₃ = M₁ + Net time deposits with banks

M₃ = 1,55,612 + 2,00,555 = Rs. 3,56,167 M₄ = M₃ + Total depostis with Post Office

M₄ = 3,56,167 + 22,500 = Rs. 3,78,667

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HOTS

Q1. How does money separate the acts of sale and purchase?

Ans. Under the barter exchange, there should be a double coincidence of wants, i.e. barter system can work only when both buyer and seller are ready to exchange each other’s goods at the same point of time.  However, such double coincidence is very rare.  With money as a medium of exchange, money can be used to make payments for all purchases and receive money for all sales of goods and services.  As a result, a person can buy or sell at different points of time with the help of money.  Hence, money has separated the acts of sale and purchases.

Q2. “Like money, goods also perform the function of store of value with same merits.”  Deferred or refute.

Ans. The given statement is refuted.  Although goods can be stored for the future, money is the most economical and convenient way. Money as a store of value helps people to transfer their purchasing power from present to future.  Goods do not perform the function of store of value because of the following problems :

• Storage of goods requires, money and efforts.
• Goods do not possess duarbility and their quality deteriorates with passage of time.
• They may not be as liquid as money, i.e., they might not be quickly converted into cash without loss of value.

Q3. State whether money supply is a stock variable or flow variable.

Ans. The money supply is a stock variable because it is expressed at a particular point of time.

Q4. State the two components of the money supply.

Ans. The two components of money supply are (i) Currency held with the public  (ii) Demand deposits with commercial banks.

Q5. What is High Powered Money?

Ans. The currency created by the central bank is known as “High Powered Money’. It includes currency (notes + coins) held by the public and cash reserves with banks.

Q6.   What is a “legal tender”? What is ‘fiat money?

Hint: Legal tender money refers to money that can be legally used to make payment of debts or other obligations. Fiat money is defined as the money which is under the Hat or order from the government to act as money i.e. under lam it must be accepted for all debts.

Q.7  Identify the function of money highlighted in the given statement.

• This function has led to capital formation and economic development of the economy.
• This function has separated the acts of sale and purchase.
• This function of money facilitates transfer of purchasing power from present to future.
• It works as a common denomination, in which values of all goods and services are expressed.
• This function of money is also termed as ‘Asset Function’ of money.
• This function has simplified the borrowing and lending operations.
• This function helps to find out exchange ratios between various goods and services.
• This function has removed the difficulty of lack of double coincidence of wants.
• This function helps to make payments for all transactions of goods and services.

Ans. (i) Standard of deferred payments

• Medium of exchange
• Store of value
• Measure of value
• Store of value
• Standard of deferred payments
• Measure of value
• Medium of exchange
• Medium of exchange.

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TRUE AND FALSE

Are the following statements true or false? Give reasons.

1. Money supply is a stock variable, as it is measured at a particular point of time.

Ans. False. The money supply is a stock variable, as it is measured at a particular point of time.

• High powered money means currency with the public.

Ans. False. Besides currency with the public, high-powered money also includes the cash reserves of banks.

• Money supply excludes money held by government.

Ans. True.  Because this does not belong to act as a medium of exchange.

• Money is a commodity.

Ans. False.  Money is a means to buy commodities.

• M₁ is also known as transaction money.

Ans. True.  Because it is directly used for making transactions.

• Medium of exchange function of money has separated the acts of sale and purchase.

Ans. True.  With the introduction of money, a person can sell his goods to anyone who offers him the best price.  And also can purchase goods from the market.

• Inter-bank demand deposits are also a part of money supply.

Ans. False.  Inter-bank deposits are not a part of the money supply, as these do not belong to the public.

• Cheques are bank money.

Ans. False.  Cheques themselves are not money.  It is the bank deposits on which cheques are written is bank money.

• Cash reserves of banks are a part of money supply.

Ans. False.  Demand deposits (rather than cash reserves) at banks are a part of the money supply.

1. Bank money is legal tender money.

Ans. False. A person can refuse to accept payment through cheque.  So, bank money is optional.

• Money helps in capital formation.

Ans. True.  Due to its store of the value function, money helps in capital formation.

• Supply of high powered money is controlled by the central government.

Ans. False.  The supply of high-powered money is controlled by the Reserve Bank of India.

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