Question

Explain primary, secondary and contingent functions of money.

Discuss various functions performed by money in an economy.

Answer 1

The different types of functions of money are:

1. Primary functions of money:
   There are two main primary functions of money:
   1. Medium of exchange: Money acts as a medium of exchange as it facilitates exchange through a common medium, i.e., facilitates exchange through currency. With money as a medium, the two components of a transaction, namely sale and purchase, can be easily separated.
   2. Measure of value: Money serves as a common medium or unit of value. The goods and services are of different types and are measurable in different units, such as metres, litres, grams, etc. Money has provided a common yardstick to measure all these different units in a common denomination known as price. This has made different goods and services comparable to each other in terms of their respective prices.
2. Secondary functions of money:
   These are those functions that money performs along with its primary functions. The secondary functions of money can be divided into the following three parts:
   1. Store of value: Generally, people have a tendency to save a certain portion of their income in the form of savings to accumulate wealth. Under the barter system, such storage of wealth was not possible due to the perishable nature of certain commodities. Against this, wealth can be easily stored in the form of money without any loss in its value. Thus, the store of value as a function of money implies that money can be easily saved and used for future needs.
   2. Standard of deferred payments: Deferred payments refer to the future payments and contractual payments such as loans and interest payments, salaries, etc. As money is widely accepted as a medium of exchange and can be used to store value without much loss in its value, it can be used for future payments.
   3. Transfer of value: Money can be transferred easily from one place to another and from one person to another. Therefore, with the help of money, purchasing power can be transferred. An individual who has money has purchasing power and he/she can transfer the purchasing power to anyone just by transferring this money. For example, when a father gives pocket money to his son, he transfers purchasing power to his son to buy different goods and services.
3. Contingent functions of money:
   The following are the various contingent functions that money performs.
   1. Basis of Credit System: In today’s economy, credit holds significant importance, especially for commercial and business operations. The entire framework of the credit system is grounded in the use of money, which serves as its essential foundation.
   2. Distribution of National Income: Money has enabled the effective division of national income among the different agents of production. Since production results from the collective input of various resources, money makes it possible to compensate each contributor appropriately.
   3. Maximisation of Utility:  A rational consumer aims to attain the highest level of satisfaction while purchasing goods and services. As covered in Chapter 3, a consumer achieves maximum utility when the ratio of marginal utilities matches the ratio of prices of different goods. Because all prices are expressed in money, it serves as a crucial tool in balancing and comparing these utilities.
   4. Employment of Factor Inputs: Producers strive to maximise profits by deciding how many units of each factor to employ. This is done by equating the marginal value product of a factor to its cost (like wages), which is expressed in monetary terms. Money thus assists producers in making informed decisions regarding the employment of production resources.