Meaning and Functions of Money

Every modern economy runs on money — yet money itself is not wealth in the way a house or a machine is; it is only valuable because it is generally accepted in exchange for goods, services and the repayment of debt. Money may be defined as anything that is generally acceptable as a medium of exchange and, at the same time, acts as a measure and store of value.

Before money existed, economies relied on the barter system — the direct exchange of goods for goods. Barter required a 'double coincidence of wants' (each party had to want exactly what the other offered), had no common measure of value, and made storing value or deferring payment nearly impossible. Money solved all three problems at once, which is why every developed economy, including India's, is built around it.

The economist Crowther's classification of the functions of money — a standard framework in Gujarat Board Std 12 Economics — groups them into three sets:

Primary functions (the two functions every textbook definition of money rests on):

• Medium of exchange — money is accepted in exchange for goods and services, eliminating the need for a double coincidence of wants.
• Measure of value / unit of account — the value of every good and service is expressed in a common unit (rupees), making prices directly comparable.

Secondary functions:

• Store of value — money can be saved and its purchasing power carried forward to a future date, unlike a perishable good.
• Standard of deferred payments — loans, wages and other payments due in the future are contracted and settled in money terms.
• Transfer of value — money allows value to be moved from one person, place or time to another, e.g. an inheritance or a remittance.

Contingent (incidental) functions:

• Basis of the credit system — banks create credit (loans, overdrafts) on the foundation of the money deposited with them.
• Measure and distribution of national income — the value of goods and services produced in the economy, and the shares (wages, rent, interest, profit) going to each factor of production, are both measured in money terms.
• Maximisation of satisfaction/utility — money lets a consumer allocate a fixed income across many goods so as to equalise the marginal utility per rupee spent, and lets a producer allocate outlay so as to equalise the marginal product per rupee, in each case maximising satisfaction or output from a limited budget.

This chapter's second half — inflation — is really about what happens when money's own value (its purchasing power) starts falling, so a firm grasp of what money actually does is the necessary starting point.