Primary Functions of Money: Medium of Exchange, Measure of Value
Primary Functions of Money: The main functions performed by money are called primary or original function. Since the entire financial structure revolves around banks and financial institutions it becomes significant to deliberate upon the role and functions of central and commercial banks.
Primary Functions of Money
The primary functions of money are as follows:
1. Medium of Exchange:
The fundamental role of money in an economic system is to serve as a medium of exchange or as a means of payment. This medium of exchange function is one of the most important and oldest function of money. Money works as a medium of exchange. The exchange was difficult in barter system due to the lack of double coincidence of wants. With the invention of money, the limitations of barter system could be overcome. Money has a generalized purchasing power. Money is used as medium of exchange;
In the barter system goods are exchanged for other goods. This system prevailed throughout the world in the olden times. This system suffered from many shortcomings, the prominent being that it necessitated double coincidence of wants. For exchange of goods, persons desiring to exchange goods must specifically want those goods what others offered in exchange. Money has removed this difficulty. Now a person A can sell his goods (say clothes) to another person B for money and then can use to buy goods (say Mobile phone) he wants from others who have these goods.
where it is earned by selling ones goods and services and used to buy another set of goods and services. The basic idea involved in this concept is that a seller may be accepting, by way of sales proceeds, an item which has no intrinsic value for him, that is, which has no economic use or utility for him.
Over recorded history, thousands of items have performed the role of money, that is, that of a medium of exchange. These days, money exists in a variety of forms. Of these, legal tender, that is, official currency [both coins and currency notes] happens to be the dominant form of money. However, quantity-wise, non-currency forms of money; Cheques, Credit Cards etc. are far exceeding the currency-money.
Money provides economic freedom to the greater extent. It helps to bring others product within our reach. The integral feature for money to serve as medium of exchange is to have a general acceptability. Any thing that is to serve this function of money must be acceptable generally by all. In other words, all should accept money for payment of goods and services. Hence, all things serving merely as a medium of exchange cannot be called money.
2. Measure of Value: Money customarily serves as common measure of value or unit of account in terms of which the values of all goods and services are expressed. This makes possible meaningful accounting systems by adding up the values of a wide variety of goods and services whose physical quantities are measured in different units. In the traditional barter economy, the evaluation of a commodity was a difficult task as it varied with the variation in the commodity exchanged. For similar reasons, it was almost impossible to keep accounting records. The invention of money has served as common denominator for value determination.
Fiat Money :
Fiat money exists where paper with no intrinsic value itself fulfils the functions of money, and government legislation ensures that it must be accepted for transaction. For example in India, rupee is the fiat money. A hundred rupee note is capable of buying goods and services worth 100 rupees, although as such the note of hundred rupees is nothing but a piece of paper.
In fact, it acts as a means of calculating the relative prices of goods and services
The monetary unit used in calculation is called unit of account. The prices of goods and services are expressed in money. This also facilitated the computation of ratio of exchange between any pair of goods. However, money as a measure of value is not perfect. For its own value does not stay constant. Unlike other invariant physical units of measures (kilograms, meter, liters etc.), the value of money changes from place to place and over time. To be satisfactory measure of value.
It is essential that monetary units must ne invariable. It must maintain the stable value. A fluctuating monetary units always creates a number of social economic problem. Normally, it may be noted that value of money i.e. purchasing power, does not remain constant; it rises during the period of falling process and falls during the period of rising prices. Hence, some economists opined that the unit of account function is desirable but not necessary quality of money.