People need to exchange one thing for another to live life. For example, the barter system allowed people to exchange one thing for another at a certain rate. However, there were many drawbacks to the barter system. There was hardly any specific measure and the exchange rates were hard to set. That is why money was introduced as a medium of exchange to buy goods.
Money is a medium of economic exchange, and it is a commodity that is accepted by all. If we look at it, it is just a piece of paper, but as the economic value is guaranteed to it, it becomes a valuable asset. Money is a very important commodity of an economy because it facilitates the exchange of everything. The value of goods and services in an economy is set in terms of money which means that goods and services can be bought and sold using money.
Money is transferred from person to person as a form of currency. It facilitates trade and helps measure wealth. People often save money to create wealth and money has been a cherished item for all right from the days of ancient history when it was introduced. Money has taken various shapes from its heydays but its functions and its mode of transaction have remained the same since its inception.
Money was introduced as a commodity. However, in its present form, it is fiat money or a government-issued legal tender. Money is a substitute for cryptocurrency, or fiduciary media in its current form.
Various functions of money are as follows:
Basically, money separates buying from selling. It helps one to avoid double coincidence of the barter system. Although credit can perform it, credit requires the financial and personal information of the buyer. This attaches cost of information and verification that can be avoided by the use of money for the sales process.
When there is a will for selling and buying something else through the proceeds of the sales process, one can do so easily by using money. Without money, one will have to look for someone who is interested and able to make the exchange possible.
The seller can sell the surplus item for money which acts as general purchasing power to anyone who wants to buy and use the money to buy something that is required for him.
The above mentioned function of a medium of exchange requires something that can be accepted both by the seller and the buyer and money fits well in this purpose. With money being the medium of exchange, the seller can sell the item and buy anything else he wants without having to prove the value of his ability for the exchange.
Therefore, money acts as a medium of exchange for everyone which is a very important function in contemporary times.
Money can also perform the act as a unit of account. As money can be used as the medium of exchange and it has a certain value that determines the worth of the currency, it can be used to calculate profits and losses, capital flow, the value of assets, and the total budget of a company.
Thus, money, as a unit of account, helps people and businesses track the record of progress or profitability.
Money also helps to accumulate value through trade or current production which can be used in the future for buying goods and services. Using money that is transferable at all places and times, one can utilize his/her ability to buy goods in different places and times via money which offers money a store of value.
As money has a certain value at any given period, it can be used as a standard of deferred payment too. By using money, one can buy a certain amount of goods and services in the present while selling the same good at the future value in the future. So, money helps in setting the deferred value of payments too.
Money can be of several types. The major forms of money are as follows:
When some forms of a mode of exchange become common in the markets, governments can issue them as a mode of currency. The government usually regulates such currencies through the use of coins and notes that have different values attached to them according to the value of the currency note which reduces the value of transaction cost further. Some forms of money are also issued as legal tender which means that courts and other government bodies must accept them as money.
Fiat money is usually supported by the economic strength of the issuing government and it gets its strength from the need for its use in tax payments. The government usually conducts monetary policy by changing the money supply to the economy. Since, fiat currencies are not commodities, the issuing government must ensure that they follow the five properties of money, namely –
Fungibility
Durability
Portability
recognizability, and
Stability.
Traders sometimes use written statements instead of money when large amounts are involved. These statements do have some properties of money and can be used in lieu of actual money. Paper checks and electronic credit are forms of fiduciary media that are used to regulate and mitigate monetary policies.
When some commodities are used extensively as a mode of exchange in a market, they can be used as a form of money. For example, gold and silver were used as market-determined money in history. Nowadays, cigarettes and instant noodles can be used for the same purpose.
Cryptocurrencies are a decentralized form of money so governments cannot regulate them. They have some properties of money but they cannot be represented in physical form. An example of cryptocurrency is bitcoin.
There are three main motives for money demand, namely –
Precautionary motive
Transactions motive
Speculative motive.
The demand for money for precaution in the future is known as a precautionary motive. Some forms of expenses, such as medical bills need immediate payments and availability of money. The motive for money in the case of such demands is known as a precautionary motive.
Money is used for transactions and it can be used to exchange goods and services. The motive to use the money for transactions is known as the transaction motive.
The speculative motive is referred to as holding money instead of lending money to earn interests as the former is considered less risky. In general, the holding of money makes it devalued due to inflation and lending money can bring an opportunity cost to the lender.
The use of money for exchange is far more convenient and useful than other modes of exchange. Money can be used as an advantage for transactions in all situations in life. It is a measure of wealth and people have been fascinated to earn money right from the days of the introduction of money. Knowing the properties, reasons of use, and motives can help in a better understanding of money and its proper use.
1. Which system was present before the introduction of money?
Ans. People depended on the Barter system before the introduction of money as a mode of exchange.
2. Which mode of money is prevalent in the modern world?
Ans. Fiat money and its use is prevalent in its modern use.
3. What is the link between money and profitability?
Ans. The link between money and profitability is that profitability is measured in terms of money.
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