Functions of Money
The main functions of money can be classified into four categories:
i) Money as a medium of exchange: This is
considered as the basic function of money. Money has the quality of general
acceptability, and all exchanges take place in terms of money. On account of
the use of money, the transaction has now come to be divided into two parts.
First, money is obtained through sale of goods or services. This is known as
sale. Later, money is obtained to buy goods and services. This is known as
purchase. Thus, in the modern exchange system money acts as the intermediary in
sales and purchases.
ii) 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.
Since all the values are expressed in terms of money, it is easier to determine
the rate of exchange between various types of goods in the community.
i) 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.
ii) 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. In other words, money now acts as the standard of
iii) Money as a Means of Transferring Purchasing Power: The field of exchange
also went on extending with growing economic development. The exchange of goods
is now extended to distant lands. It is therefore, felt necessary to transfer
purchasing power from one place to another.
i) Basis of the Credit System: Money is the basis of the Credit System.
Business transactions are either in cash or on credit. For example, a depositor
can make use of cheques only when there are sufficient funds in his account.
The commercial bankscreate credit on the basis of adequate cash reserves. But,
money is at the back of all credit.
ii) Money facilitates distribution of National Income: The task of distribution of national income was
exceedingly complex under the barter system. But the invention of money has now
facilitated the distribution of income as rent, wage, interest and profit.
iii) Money helps to Equalize Marginal Utilities and Marginal
Productivities: 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 an
important role, because the prices of all commodities are expressed in money.
Money also helps to equalize marginal productivities of various factors of
iv) 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. It is on account of this liquidity of money that capital can be
transferred from the less productive to the more productive uses.
i) Money helps to maintain Repayment Capacity: Money possesses the
quality of general acceptability. To maintain its repayment capacity,
every firm has to keep assets in the form of liquid cash. The firm ensures its
repayment capacity with money. Likewise, banks, insurance companies and even
governments have to keep some liquid money (i.e., cash)to maintain their
ii) 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 served.
iii) Money gives liquidity to Capital: Money is the most liquid
form of capital. It can be put to any use.