Meaning and Functions of Money

Money is anything that is generally accepted by people as a medium of exchange and in the settlement of debts. Notice that acceptability, not any physical property, is what makes an object money. A ten-rupee note is a small piece of printed paper; what gives it value is the shared confidence that everyone around us will accept it in return for goods and services. Economists therefore prefer a functional definition: money is what money does.

Before money existed, exchange happened through barter — goods swapped directly for other goods. Barter suffers from serious problems: it needs a double coincidence of wants (a person with rice who wants cloth must find someone with cloth who wants rice), goods cannot be sub-divided (you cannot pay half a cow), there is no common measure of value, and wealth is hard to store. Money was invented precisely to overcome these difficulties, and its functions map directly onto the problems it solves.

Primary (main) functions

These are the functions money performs everywhere, at all times.

• Medium of exchange — money sits between the buyer and seller, so goods are first sold for money and money is then used to buy other goods (C–M–C). This removes the need for a double coincidence of wants and is the single most important function of money.
• Measure of value (unit of account) — money provides a common yardstick in which the value of every good and service can be expressed. Once prices are all stated in rupees, we can compare, add and calculate values easily, and keep accounts.

Secondary (derivative) functions

These functions are derived from the primary ones and extend money's usefulness over time.

• Store of value — money can be held and its purchasing power carried into the future, letting people save now and spend later. It is the most liquid store of value because it can be spent instantly without conversion.
• Standard of deferred payment — contracts, loans and instalment purchases are settled in future in terms of money. Money's general acceptability and (reasonable) stability make it a convenient standard for payments spread over time.

Contingent functions

Writers such as Kinley list further functions that money performs incidentally in a modern economy:

• Distribution of national income — rewards to land, labour, capital and enterprise (rent, wages, interest, profit) are measured and paid in money.
• Basis of credit — bank deposits and credit instruments (cheques, bills) rest on money; without money, a credit system could not function.
• Maximisation of satisfaction — a consumer equates marginal utility per rupee across goods, and a producer equates marginal returns per rupee across factors — both use money as the common measure.
• Liquidity — money is perfectly liquid, so wealth held as money can be converted into any other asset instantly, giving the holder flexibility.