Functions of Money
During the course of history money has taken various forms. In fact, there is no difficulty in identifying money but the problem is defining money. Economists rely on the functional definition that 'money is as money does' i.e. money is any asset which performs the functions of money. What are the functions of money?
1. A Medium of Exchange: One of the primary functions of money is to act as a medium of exchange i.e. it is acceptable in payment for goods and services. Money eliminates the necessity of finding the double coincidence of wants. Each person simply exchanges his output for money and then exchanges the money for the goods and services he requires.
Without money the gains from specialization and exchange would have been impossible. If trade was conducted on the basis of barter, markets would have been small and localized and benefits of economies of scale would have been impossible. And this inefficient use of resources would have been compounded as time and effort would have to be spent seeking out a double coincidence of wants. Money as a medium of exchange makes mass production and benefits of economies of scale possible.
2. Unit of Account: Money also acts as a means of expressing the value of different goods and services. Another problem in barter system was the mutually acceptable rate of exchange between the commodities traded. The acceptance of money as a medium of exchange has made possible to express the prices of all commodities in terms of rupees, and thus enables to compare relative values or prices. If one gram of gold costs Rs.450 and one gram of silver costs Rs.9, we know that gold is 50 times as valuable as silver.
Such comparisons are important to consumers and firms in making consumption and investment decisions. In the absence of money comparisons would be difficult, as every class of goods and services would need to be expressed in terms of every other class of goods and services to have complete information. Thus, one gram of gold might be worth 4 pairs of shirts, 9 pairs of slippers, 5 pairs of shoes and so on. Thus, a single unit of account is much easier to compare relative values.
3. A Standard of Deferred Payments:This function of money is closely related to its function of 'Unit of Account'. Money enables us to trade at price agreed today but payment to be made in the future. Without money it would have been difficult to agree what would constitute an acceptable rate of payment in the future. Firstly, we do not know with certainty what goods we will have in the future and secondly we do not know what we will require in the future. This problem is solved by agreeing to a money price which, on payment, can be converted into those goods and services which will be required at that time.
4. A Store of Value: Money provides a means of strong wealth. It is often easier and more convenient to store wealth in the form of money than in any other form such as real assets, paper assets, etc. Since money is a medium of exchange, it follows that it is the most liquid asset of all. Though it does not yield monetary returns comparable to what one gets by storing the wealth in the form of real assets, etc. people store at least part of their wealth in the form of money because money provides immediate purchasing power. It can be used in meeting any and all financial obligations.