1.3. Functions and Significance of Money

Medium of exchange: In almost all market transactions in our economy, money in the form of currency or cheques is a medium of exchange; it is used to pay for goods and services. The use of money as a medium of exchange promotes economic efficiency by minimizing the time spent in exchanging goods and services. It eliminates the problem of going and finding services provided by specialized people a practice prevalent in barter system. The time spent in trying to exchange goods or services is called a transaction cost. In a barter economy, transaction costs are high because people have to satisfy a “double coincidence of wants”—they have to find someone who has a good or service they want and who also wants the good or service they have to offer.

Unit of account: Another important role of money is to provide a unit of account; that is, it is used to measure value in the economy. We measure the value of goods and services in terms of money, just as we measure weight in terms of kilos or distance in terms of meters. In barter system this advantage is missing as one cannot calculate and compare the prices of two different entities available in the market.

Store of Value: Money also functions as a store of value; it is a repository of purchasing power over time. A store of value is used to save purchasing power from the time income is received until the time it is spent. This function of money is useful, because most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until we have the time or the desire to shop. Even though there exists a number of means to store value such as house, jewelry, stocks etc. yet money has the most liquidity and acceptability of them all.

Standard of Deferred Payments: Money facilitates not only the current transactions of goods and services but also their credit transactions. It facilitates credit transactions when present goods are exchanged against future payments. In the modern world, the bulk of deferred payments are stipulated in money terms only. Examples in this regard are repayment of loan along with interest, pensions, rents, salaries, insurance premium, etc. Money could be an

effective standard of deferred payments only if value of money itself does not change. If prices increase or decrease sharply, resulting in large fluctuations in the value of money, it would make money a poor standard of deferred payments.

Distributor of National Income: Money helps in the distribution of national output among the people who have contributed in its production. In a modern society people co-operate together as workers, owners of capital, landlords, etc., to produce goods. The resultant output is, therefore, to be distributed among all of them in the form of wages and salaries, interest, rent, etc. In the absence of money it would not always be possible to distribute such an output, particularly in case of indivisible goods, e.g. a machine. With the help of money we can overcome such a problem.