Functions of Money:
Money performs several important functions. Prof. Kinley has classified the functions of money into three groups :
1. Primary functions
2. Secondary functions
3. Contingent functions
1. Primary Functions :
They are the fundamental and essential functions. These functions must be performed by money in every economy under all circumstances.
a. Medium of Exchange
b. Measure of Value
a. Medium of Exchange :
- Money serves as a medium of exchange. Money commands general purchasing power to purchase goods and services which people want.
- Money is used for making purchase and sales. Money is used for buying goods and goods are exchanged for money while selling goods.
- Money has removed the inconvenience and inefficiency which characterise the barter system.
- Money has avoided the wastage of time and resources involved in exchange, and has eliminated the need for double coincidence of wants needed in barter.
- Money has facilitated the exchange and removed wastage of time and resources.
b. Measure of Value:
- The second important function of money is that it acts as a common measure of value or Unit of Account.
- For measuring the value of a commodity, we take money as a unit of account.
- Money serves as the unit of measurement in terms of which the value of all the goods and services are measured and expressed.
- The value of any good, expressed in terms of money, is the price of the good.
- When the value of all goods and services is expressed in terms of money, it is easy to establish the relative value of goods or their Price.
- Since the value of all the commodities in the market are expressed in terms of money, it becomes easy to determine the rate of exchange between them by comparing their market prices.
- For example, a pen is priced INR 10 and a register is priced at INR 40 thus the relative is
1 register : 4 pens
- This function has removed the problem of lack of common measure of value.
2. Secondary Functions of Money:
a. Standard of Deferred Payments
b. Store of Value
c. Transfer of Value.
a. Standard of Deferred Payments:
- This function of money is the extension of medium of exchange function. Money serves as a standard of deferred payment.
- It means money is also used to make payments to be made in future.
- As soon as money is used as a medium of exchange and measure of value, it is also used as a unit in which all future payments are made.
- In modern economy, a large number of transactions involve payments in future. For example, interest, rent, salaries, pensions, loans, insurance premia are the transactions which involve such future payments expressed in money terms.
- This function of money is supported by the features that money has general acceptability and purchasing power and has stable value.
- This function has facilitated the credit creation in money.
b. Store of Value:
- Money also serves as a store of value i.e., people can keep their wealth in the form of money.
- Money is a perfect liquid asset, it is readily and generally acceptable means of payments.
- Holding of money means, holding the purchasing power of any good and service at any time.
- Money can easily converted in to desired goods and services.
- Money allows us to store purchasing power which can be used at any time in future to purchase goods and services including other assets.
- It also has stable Value.
c. Transfer of Value :
- Money also serves as a means to transfer value.
- This function of money arises from the general acceptability of money as a medium of exchange.
- Money helps in the transfer of value from one person to another and also from one place to another.
- Money is of great help in transferring the value easily, quickly and efficiently.
- We can sell a house in Delhi in exchange for money and can use the same money in buying a house in Kolkata.
3. Contingent Functions of Money :
Contingent functions refers to the role of money in assisting various economic entities such as consumers, producers etc. in taking economic decisions relating to consumption and production etc. These are:
a. Maximisation of Utility
b. Employment of factor input
c. Distribution of National Income
d. Basis of Credit System
a. Maximisation of Utility:
- A rational consumer will spend his income in such a way, to maximises his total utility by his purchase.
- The consumer will maximise his utility by equalising the ratios of marginal utility of a commodity to its price, with this ratio for another commodity –
(MUx / Px) = (MUy / Py) …….Law of equimarginal utility
- For equalising the marginal utilities, money plays an important role because prices of all the commodities are expressed in terms of money.
b. Employment of factor inputs:
- Every producer aims at maximisation of his profit with employing various factors of production.
- The profit maximising producer will equate marginal productivity of factor with its price.
- Since the factor prices such as wages, rents etc. are expressed in terms of money, it is money which helps the producers to arrive at the decisions with regards to the number of units of a factor of production to be employed.
c. Distribution of national income:
- Money has facilitated the distribution of national income among the factors of production.
- Production is the outcome of combination and collective efforts of various factors of production.
- Contribution of these factors of production to the production process is rewarded not in terms of goods but in terms of money.
d. Basis of Credit System:
- This function is based on the store of value function of income.
- It is money which provides the basis of the entire credit system.
- Without money borrowing and lending are not possible and neither the credit creation.
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