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Functions of Money

Updated on November 11, 2013

Functions of Money

We can classify functions of money into three groups. They are:
1. Primary Function
2. Secondary Function and
3. Contingent Functions

There are two primary function of Money they are:

1. Medium of exchange
2. Measure of value.

Primary functions of Money

Money as a Medium of Exchange: The function of money as a common medium of exchange facilitate the activity of buying and selling of goods and services.  This function effectively solve the problems of a barter system. It is the most important and unique function of money which separates it from near-money assets.  Money splits exchange into two parts.  Sale and Purchase.

Money as a measure of value
: Money act as an instrument for measuring goods and services in terms of their money value.  In the absence of money, it would be tedious to measure the value of goods and services for the purpose of exchange.  Thousands of goods are available in the market.  You can imagine how difficult it is to exchange these goods if there is no common medium to value these goods and services.   One person who is offering his product to different people should keep thousands of values for his one product to effectively do his business.   Money removes this problem by acting as a common medium.  Due to the introduction of money, a trader should keep only one value for his each goods and services. Also it is to be noted that different goods are measured in different physical units like Litter, Kilogram, meter etc.  Comparison of value of goods which has different physical units also possible if you know the money value of each goods.

Comparison of goods in different region or time is possible through knowing the money value of the goods. The use of money price also help us in estimating national income by adding up values of a wide variety of goods and services which are measured in different physical units.

Money as a measure of value can serve satisfactorily only when its own value (i.e. purchasing power) remains stable over time.  Continuous rise in general level of prices all over the world has made money a poor measure of value.

Secondary Functions of Money

Secondary functions are:
1. Money as a standard of deferred payments
2. Money as a store of value
3. Money as a means of transferring purchasing power

Let us looking into it in detail

Money as a standard of deferred payments:  Money facilitates not only the current transactions of goods and services but also their credit transactions.  It facilitates credit transactions when goods are exchanged against future payments.  Now a days deferred payment is become our  part of our life as loan installments, pension, insurance premium etc are paid as deferred payments.  Money could be an effective standard of deferred payment.  For that purpose the value of money should be stable.  If prices increase or decrease sharply, resulting in large fluctuations in the value of money, it would make money a poor standard of deferred payments.

Money as a store of Value:
We can store or hold a part of our present earnings in the form of money to be spent in future.  Money represents generalized purchasing power and is a perfectly liquid asst as well.  It is stable in value and useful in purchasing goods and services to satisfy human wants in a future time.  Also we can store it for a longer period and need less space than other goods. So it is convenient to accumulate wealth in the form of money which can be converted in to any asset at any time.   Money serve as a bridge from the present to the future as money saved today can shift our purchasing power from the present to the future.

Money as a means of transferring purchasing power:
Money is the most convenient form in which value can be transferred from one person to another and also one place to another.  The reason is that it is light weight, high value and less space consuming as compared to other goods.  Also everyone readily accept money irrespective of  place.   For example, transferring thousands of kilograms of food grains would be time consuming, expensive and incur a lot of efforts and wastage.  On the other hand transferring value of that much food grain in the form or money is less expensive and easy by a cheque or a bank draft.  So money act as a means of transferring purchasing power.

Contingent Functions of Money

Contingent Functions

1. Distribution of National Income
2. Basis of credit system
3. Maximization of utility and profits
4. Money imparts liquidity and uniformity to assets

Distribution of National Income: In the modern world  people join together to run a business organization. Many people contribute their money, efforts, skills and space etc.  When that business organization make profits, it should be divided as per the proportion of efforts or skills or money put in by all those who are involved.  Money helps in the distribution of national income among the people who have contributed in its production.  This income is divided or distributed in  the form of rent, wages, salary, interest, renumeration  etc.  It is very difficult to determine and and remunerate those who contributed machine, property or materials.  This problem can be easily overcome by determining the money value of such properties and distribute income proportionate to their contribution.  So money helps in the distribution of national output among the people.

Basis of Credit System: The present day money (Coins, currency notes, cheques, bank drafts etc) is a promise to pay.  The modern economy is based on promise to pay.  One of the area of function of bank is to receive money from depositors and lend it to those who are in need for running business or purchasing goods.  Banks charge a fixed or variable rate of interest for their service.  Depositors also get a portion of interest for their deposits.  So money can serve as a basis of credit system. 

Maximization of utility and profits:  If a farmer who does farming make one or two types of crops in bulk quantity.  If he sell it for cash, he can use that money for satisfying his many of the needs.  Keeping food grains limits his utility.  On the other hand when he turns it into cash i.e. money,  his scope of utility increase.  Likewise producers of goods can calculate the cost of production in the value of money and decide a selling price which is profitable.  In this way they can maximize their profits.  So another use of money is that maximization of utility as well as profits.

Money imparts liquidity and uniformity to assets:
  Money is convenient form for holding the wealth.  As money can buy any asset at any time.  As well as any assets can be converted in to money.  So money is the most liquid form of asset.  Another function of money is it can calculate the wealth of the person by calculating the value of his property and things that are in his possession in the form of money value.  Total wealth of a person or a country can be ascertained by calculating the money value of all assets.  So the another function of money is that it imparts liquidity and uniformity to assets.


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