Question

Explain the functions of money.

State the main functions of money.

Answer 1

1. Primary Functions:
   1. Money as a medium of exchange: This is considered the basic function of money. Money possesses the quality of general acceptability, and all transactions occur in terms of money.
   2. Money as a measure of value: The second important function of money is that it measures the value of goods and services. In other words, the prices of all goods and services are expressed in terms of money. Money is thus looked upon as a collective measure of value.
2. Secondary Functions:
   1. Money as a Store of Value: Savings done in terms of commodities were not permanent. But, with the invention of money, this difficulty has now disappeared, and savings are now done in terms of money. Money also serves as an excellent store of wealth, as it can be easily converted into other marketable assets, such as land, machinery, plant, etc.
   2. Money as a Standard of Deferred Payments: Borrowing and lending were difficult problems under the barter system. In the absence of money, the borrowed amount could be returned only in terms of goods and services. But the modern money economy has greatly facilitated the borrowing and lending processes.
   3. Money as a Means of Transferring Purchasing Power: The field of exchange also continued to expand with growing economic development. The exchange of goods is now extended to distant lands.
3. Contingent Functions:
   1. Basis of the Credit System: Money is the basis of the Credit System. Business transactions are either in cash or on credit.
   2. Money facilitates the distribution of National Income: The task of distributing national income was exceedingly complex under the barter system.
   3. Money helps to Equalize Marginal Utilities and Marginal Productivities: The consumer can obtain maximum utility only if he incurs expenditure on various commodities in such a manner as to equalize marginal utilities accruing from them. Now, in equalizing these marginal utilities, money plays a crucial role, as the prices of all commodities are expressed in monetary terms.
   4. Money Increases Productivity of Capital: Money is the most liquid form of capital. In other words, capital in the form of money can be put to any use.
4. Other Functions:
   1. Money helps to maintain Repayment Capacity: Money possesses the quality of general acceptability. To maintain its repayment capacity, every firm must maintain assets in the form of liquid cash. The firm ensures its repayment capacity with money.
   2. Money represents Generalized Purchasing Power: Purchasing power kept in terms of money can be put to any use. It is not necessary that money should be used only for the purpose for which it has been earned.
   3. Money gives liquidity to Capital: Money is the most liquid form of capital. It can be put to any use.