Tuesday, November 1, 2011

Money, its functions, characteristics & importance

All about your Money Honey… Part 2

In continuation to Barter System & its disadvantages over Money, now let us understood why was there a need for “Birth of Money to bring an end to the Barter System”

Money is a social convention.
 “We accept money as payment because we expect others to accept it from us”.

In Brief, Money is anything that people will accept in exchange for goods or services, in the belief that they may in turn exchange it, now or later, for other goods or services. Right from birth to death, everybody requires money at every stage of life. It is the honey baby/heartthrob of every heart.

As we know “Money is what money does” , so let’s see the functions of money.

Functions of Money (What Money does?)
The functions of money are the same which were defects in
barter system. More formally, Money in classical economics is defined by functions it performs as

(1) a Medium of Exchange
          Money acts as a medium of exchange which can be used for buying and selling goods and services. This transfer of money from buyer to seller allows the transaction to take place. It plays a mediator role between purchases and sales. It replaced barter system with money exchange system.

(2) a unit of account
          Money is the common standard for measuring relative worth of goods and service. Money is used to designate the prices of goods and services. Any item that is generally accepted as payment for goods and services is also the obvious choice for denominating the prices of those goods and services.

(3) a storage of value
         Money's value can be retained over time and a convenient way to store wealth.  Money can be used to transfer purchasing power from present into the future.

(4) a standard of deferred payment
          Money is used to designate future payments, such as those for loan repayments. The standard of deferred payment is a natural result of the standard unit of account and store of value functions of money.

Now it is clear that functions of money have removed those difficulties which were in barter system.

The Characteristics of Money:

1) Durability
          Durability means that the item must be able to exist for a long time without deterioration and to withstand being used repeatedly.
Durability is critical for money to perform the related functions of medium of exchange and store of value. Items that are considered Currency, coins and paper bills used as money meet this requirement. In Modern days, Money is made out of paper, metal and plastics which make money long lasting.

2) Portability (Easily Transported)
          Portability means that individuals are able to carry money with them and transfer it easily to other individuals.
This is why coins and paper money have historically proved popular. In modern days money is carried from one place to another with less effort where a wallet can carry any type of money including, notes, coins and debit cards.

3) Divisibility
          Divisibility means that the money can easily be divided into smaller units of value.
When people used stones and tobacco as money they were not able to divide those into small pieces in a standard form where they used it whole or divided into small pieces but it was lacking standardization. In modern days people have notes and coins from low values to high value where they are used to divide money into small units of account.

4) Uniformity
           Uniformity means that all versions of the same denomination of currency must have the purchasing power.
As an example, a 1928 $5 bill will still buy $5 worth of goods or services today. 

5) Limited Supply
            Limited Supply means that restrictions on the amount of money in circulation ensure that values remain relatively constant for the currency.
Currently respective country's Government has the responsibility to control / maintain an adequate money supply to the market based on their monetary policies.

6) Acceptability
            Acceptability means that everyone must be able to use the money for transactions.
Money is universally accepted anywhere in the world as a universal mean for transaction.

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