MONEY AND BANKING
Money is the standard currency. Money has no role in an economy with only one individual, as there is no exchange of commodities. If multiple individuals do not participate in market transactions, such as a family on an isolated island, money has no value for them. When multiple economic agents engage in market transactions, money becomes a crucial tool for facilitating exchanges. Barter exchanges are economic transactions that do not involve money. However, they assume the unlikely coincidence of two wants. For instance, a person with excess rice wants to trade it for clothing. If she is unlucky, she may not find someone with a completely opposite rice demand and clothing surplus to trade. The search costs may become prohibitive as the number of individuals increases. An intermediate good that is acceptable to both parties is necessary to smooth the transaction. The good is money. Individuals can sell their produce for money and use it to buy necessary commodities. Although money primarily facilitates exchanges, it also serves other purposes. The main functions of money in modern economies are listed below.
1.Medium Of Exchange: Money serves as a pivotal medium of exchange in an economy, streamlining transactions and negating the need for a cumbersome barter system. This simplification extends beyond merely matching opposite wants; it enables a more complex division of labour. Individuals and businesses can specialise in specific tasks or services, confident that they can use money to acquire what they need elsewhere.
2.Unit Of Account: A unit of account is another critical function that money serves. With a standardised metric, such as the rupee, it’s much easier to compare and assess the value of various goods and services. This standardisation influences both consumers and producers in their decision-making processes, promoting economic efficiency.
3.Purchasing Power: The purchasing power of money can fluctuate due to various economic factors like inflation or deflation. These changes in the general price level affect the amount of goods or services a unit of money can purchase. This variability in purchasing power has implications for individual savings, financial planning, and government policy.
4.Store Of Value: Money’s role as a store of value allows individuals and entities to defer consumption or investment decisions into the future. Unlike perishable goods, a stable form of money maintains its value over time, making it an excellent medium for saving and long-term planning.
5.Liquidity And Convertibility: While other assets such as gold and real estate can also serve as stores of value, they lack the liquidity and universal convertibility that money offers. For example, it’s far more challenging to divide a piece of land or a gold bar to make small transactions, making these assets less practical for day-to-day use.