Page 142 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 8: Money

Notes
Example: A currency note is a mere piece of paper, and its intrinsic value is zero. Still the
public accepts paper money (currency) because government has taken steps to ensure that it is
accepted.

8.1 Functions of Money

“Medium of exchange” is the primary function of money. For anything to be called money it
must serve as a medium of exchange. Alongwith the necessary function, money also performs
other functions: a store of value, a unit of account, a standard of deferred payment.
Medium of Exchange: The alternative to medium of exchange is “barter”, that is exchange of
goods for goods. But there is a problem with barter. Barter system requires double coincidence of
wants for trade to take place. This involves intolerable amount of effort.
Money eliminates the barter problem. This makes money vital to the working of a market
economy. Money makes an economy a monetary economy.

Store of Value: The function means that money serves as an asset that can be used to transport
purchasing power from one time period to another. One can keep one’s earning in the form of money
until the time one wants to spend it.

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Caution Goods can also serve store of value. But money has two important advantages
over goods; (i) money comes in convenient denominations and is easily portable, and
(ii) it is easily exchanged for goods at all times. These two factors compose liquidity property
of money.
As a store of value, money also has a disadvantage. Over a time period, value of money changes
as price level changes. By value of money we mean the amount of goods and services we can buy
from a unit of money. When price level rises, value of money falls.
Unit of Account: Money serves as a standard unit for quoting prices. It makes money a powerful
medium of comparing prices. It also makes keeping of business accounts possible.
Standard of Deferred Payment: Money serves as a standard of payment contracted to be made at
some future date. It facilitates borrowing and lending activities. It is responsible for the existence
of banks and other financial institutions. Financial institutions are the lifeline of modern business.

Caselet Deflation and Demand for Money

he argument that deflation resulting from an increase in the demand for money can
lead to a harmful reduction in industrial productivity is based on the concept of
Tsticky prices. If all prices do not immediately adjust to changes in the demand for
money then a mismatch between the prices of output and inputs goods may cause a
dramatic reduction in profitability. This fall in profitability may, in turn, lead to the
bankruptcy of relevant industries, potentially spiraling into a general industrial fluctuation.
Since price stickiness is assumed to be an existing factor, monetary equilibrium is necessary
to avoid necessitating a readjustment of individual prices.

Source: www.cobdencentre.org

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