Money
The Barter System
Before the introduction of money, goods and services were exchanged directly for other goods and services. As the extent of specialisation increases, however, the barter system becomes very innefficient and frustrating.
Problems with the Barter System
- The double coincidence of wants – the wants of both parties should agree and sell at the same time.
- Problem of Exchange Rate – a horse cannot be traded for a needle, because the horse has higher value than a needle
- Difficult to store wealth in the form of goods because goods are highly perishable and storage limitations.
What is money?
It refers to anything that is generally accepted as a means of payment or medium of exchange.
Functions of Money
- It acts as a medium of exchange – Money is used to buy and sell goods and services, eliminating the inefficiencies of a barter system (which requires a double coincidence of wants).
- It acts as a store of value – Money provides a common standard for measuring the value of goods and services, making it easier to compare prices.
- It acts as a measure of value and unit of account – Money allows people to store wealth and use it in the future, retaining its value over time (provided there is low inflation).
- It acts as a standard of different payments – Money can be used to settle debts or make payments in the future, making credit transactions possible.
Characteristics of Money
- Uniformity – All units of money must be identical in value and appearance for easy recognition and fairness.
- Portability – Money must be easy to carry and transfer from one person to another.
- Acceptability – Money must be widely accepted by people and businesses in exchange for goods and services.
- Durability – Money should be able to last over time without wearing out easily.
- Scarcity – Money should be in limited supply to maintain its value; if too much money is in circulation, it can lead to inflation.
The Value of Money
Goods and services are valued in terms of money. When the price increases, the quantity of goods that can be bought with a given amount of money decreases, and vice versa. The value of money can be differentiated as the nominal value of money and the real value of money.
- Nominal Value of Money – The Nominal value is just the face value of money for instance, Rs 100 is Rs 100. Thus, it’s just how much money you have.
- Real Value of Money – The real value of money is the purchasing power of that money. For instance, if you hold a Rs 100 bank note and the inflation rate is 10% then real value of money is (100/1+0.10) Rs 90.91. Thus it’s just what that money can buy.