MCom I Semester Business Environment Money Notes Study Material
Table of Contents
MCom I Semester Business Environment Money Notes Study Material: Meaning and Definition of money Functions of money Important of Money Determination Value of Money General Price level and Value of Money Assumption of the Quantity Theory of Money Criticism of Quantity Theory of Money Income Theory of Value of Money Characteristics of Saving and Investment theory of Money Long Answer Questions Short Answer Questions Objective Questions ( Most Important Notes for MCom Students )
CTET Paper Level 2 Previous Year Science Model paper II in Hindi
Money
In the early stages of human existence, the barter form of exchange was in use, for people had limited wants. As human civilisation progressed, people had to face many problems because of the inconvenience caused by the barter system of exchange. Then ‘commodity money’ came into existence. Giving up of less durable commodities gave rise to the introduction of durable commodities such as durable metals like gold, silver, bronze etc. Later on, these metals took the form of coins. Thus, metallic coins came into existence. Again with rapid industrialisation and economic progress coins were replaced by paper currency. Still later, in addition to the paper notes, bank money-cheque, drafts, bills of exchange came into use. Presently plastic money i.e., credit card, debit card and electronic exchange (e-exchange) are in circulation widely. Now the bank deposits serve as the most important type of money because the bank money is accepted by everyone and everywhere.
Money Notes Study Material
MEANING AND DEFINITIONS OF MONEY
The origin of money is deep rooted in antiquity, it is certainly as old as recorded history, but its nature and form have been changing with every change in the form and level of industrial life. The history of money reveals that a bewildering variety of commodities and other things have been used as money at different times and different places. Money is known and recognised by every one and it is also known that we encounter greater difficulty in attempting to state precisely what money is. The ‘money’ has been defined differently by different writers. Some definitions of money from eminent authors are as follows:
1 According to R.P. Kent, “Money is anything that is commonly used and generally accepted as a medium of exchange or as a standard of value.”
2. In the words of Knapp, “Anything that is declared money by the State, becomes money.”
3. According to Walker, “Money is what money does.” 4. Hartley Withers has defined money as, “the stuff with which we buy and sell things.”
The definitions given above, reveal that the money serves as a medium of exchange. unit of account and store of value. Some definitions emphasize general acceptability of money.
Money Notes Study Material
FUNCTIONS OF MONEY
Money is put to different uses in an economic society. The fundamental purpose of money is to serve as a medium of exchange and as a measure of value. Money also serves as a standard of deferred payments and as a store of value. It also performs several other functions in a modern economy. The functions of money are as follows:
1 Primary Functions of Money : Primary functions of money are also known as ‘fundamental’ or ‘basic function of money. These are the functions which have been performed by money in all countries at all times and under all the conditions. The primary functions of money are as follows:
(i) Fixation of values of commodities : Money serving as a unit of account removes another inconvenience of barter, lack of a common measure of value. Money is used to measure the value of all kinds of goods and services. Money as a unit of account helps in comparing the relative values of goods and services. Money exchange is capable of providing solution of division and sub-division of commodities. It also enables fractional sale and purchase of commodities. Entirely different kinds of economic factors can also be measured in proportion to their prices.
(ii) Medium of exchange : Money removes all the difficulties of barter system. Money facilitates trade by providing a medium which everyone is willing to accept in exchange for goods and services or in payments of debts. The medium of exchange function can be served by anything which is generally or commonly accepted by people in exchange for the goods and services. The use of money as a medium of exchange has broken up an exchange of goods for goods into two transactions-purchases and sales. Money functioning as a medium of exchange has perfected the price mechanism. It has also greatly assisted productive operations.
2. Subsidiary Functions of Money: In addition to its primary functions, money performs the secondary or subsdiary functions. They are as follows:
(i) For future savings : The holder of money may either spend it or hold it for future. It implies the shifting of purchasing power from present to the future. Storing wealth in the form of gold, silver etc. too are unsafe. Money serves as a store of value, which can be kept for longer period without devaluation. The store value of money has contributed in the development of banking system.
(ii) Easy transfer of value : The use of purchasing power or value is transferred from one time to another. An equally important function of money is to help in the transference of value from one place to another and from one person to another. It does not involve any difficulty to transfer the value of different assets and properties from one place to another within the country or between the countries. Because of its easy transferability and general acceptability, it has facilitated the transfer of value from one person to another and from one place to another.
(iii) Deferred payments : Money comes into general use as a medium of payments and as a unit of account not one for immediate transactions, it also serves as a standard of deferred payments when obligations to make future payments are stated in terms of it. Lending, borrowing and hire purchase transactions must be based on the item which should keep its value comparatively stable. The value of money can be kept stable, if properly managed, for quite a long period of time. Loans and debts are measured in terms of a stable store of value, i.e., money.
3. Other Functions of Money : Apart from primary functions, money also performs some contingent functions. These tu money keep on increasing and changing with the changing needs of these These functions are as follows:
(i) Function of distribution of income: Money facilitates the distribution of the national income between the different factors of production. A highly specialised process of production at a large scale needs an active cooperation of millions of people. The resulting production belongs to all of them jointly. Without money the distribution of the product among the various factors of production would be impossible. Money not only facilitates the distribution of social income, it also helps in bringing justice in distribution.
(ii) To know solvency capacity : Money is the guarantor of solvency. The liquid money of a person, a firm, or an organisation guarantees solvency. Thus, money helps in keeping the solvency of a person, firm, a bank or an organisation. If some one fails to pay all the debts, he can be called as insolvent. Therefore, the money also serves as a sign of solvency.
(iii) For credit system : Money serves as a basis of the vast structure of modern credit system. Banks create credit on the basis of their cash reserves. All credit is based on money and is always expressed in terms of money. Credit is the foundation of modern commerce and it has played an important role in the development of modern economic system. Any change in the volume of credit is brought about mainly by increase or decrease in money supply.
(iv) Uniformity in Capital resources : Money as “the embodiment of generic value” imparts mobility and liquidity to capital. It also imparts uniformity to different forms of wealth into money, they all become uniform. Money flows into the field of production as soon as it is needed there. It is true that money is not a productive agent, but it cannot be denied at the same time that it helps in extending production. It exercises an influence to keep production at its maximum. Universal acceptability of money has made it as liquid capital. Money helps in making the capital liquid, productive and mobile.
(v) Used in various objectives : Money can be used to attain various objectives. Savings in the form of money may be used for the production. Money has helped in moblising capital because of its nature of ‘high value in low bulk.’ When savings are made it can be decided on a future date the manner in which he is going to utilise his savings. Hence, it is necessary to keep savings in the form of money. Since money is the only universally acceptable medium of . exchange it can be exchanged with anything of choice.
(vi) Getting maximum utility : A consumer gets the maximum satisfaction when the prices of the commodity is equal to the marginal utility of the commodity. Money serves us a means of equalizing marginal utilities. A consumer can follow the principle of equi-marginal utility. He can conveniently make changes in the purchases of commodities, so as to desire maximum satisfaction. This type of changes in purchases can be introduced with the help of money. Equalization of marginal utilities is, thus, possible only with the help of money.
The static functions of money are as important as its dynamic functions. By its static functions, money serves as a possible technical device ensuring a better operation of economic system. The stability of value of money is an essential quality which enables money to fulfil its static functions properly. The primary and secondary functions of money are its static or technical functions. But dynamic functions, money tends to exert a powerful influence on the economic, entities like the trends of price level, volume of production and consumption rate of saving and investment, level of employment and income and the distribution of the wealth, etc. Money performs its dynamic functions by serving as a means of distribution of social income and also as a means of achieving justice in distribution of the wealth, etc, Money performs its dynamic functions by serving as a means of distribution of social income and also as a means of achieving justice in distribution. It also brings equalization of marginal utility in expenditures, serves as a basis of credit system and imparts liquidity, mobility and uniformity to capital.
Money Notes Study Material
IMPORTANCE OF MONEY
Money plays an important role in the shaping of the economic life in a country. Money is the characteristics of nearly very highly developed civilisation and it is necessary for such development. An effectively operating monetary mechanism is a necessary condition for the smooth working of the economy. Classical economists did not attach much significance to money as an independent variable capable of disturbing the functioning of the entire economy. For them money was simply a device merely as the means of acquiring the goods and services which are the real objects of their desire. In modern economies, money has been considered as the most dynamic element in the economy and as a ‘link between the present and the future’. Money being inherently unstable, is not likely to manage itself in the best interests of the economy. The importance of money is described as under:
(i) Importance in consumption: The consumer has been greatly benefited with the invention of money. The consumer may postpone his demand today, if he so desires. It is not necessary for the consumer to spend money as soon as he obtains it. Due to general acceptability and comparative stability of money the consumer can utilise it as and when it suits, him. A consumer gets maximum satisfaction when he adjusts his expenditure in such a way that each unit of money spent by him brings him goods of equal marginal utility.
(ii) Importance in production : Money has facilitated achieving high production and wide distribtion of the benefits at any one time. Money helps the individual producer in a variety of ways, such as in buying raw materials, in borrowing loans and in combining various factors of production. Without money, these productive activities can not be carried on. Money helps the producers in making various types of calculation regarding production.
(iii) Importance in distribution: The production is the joint effort of all factors of production. The rewards of these factors of production are distributed in terms of money. Rent, interest, wage and profits are all determined and paid to the factors of production in terms of money. Thus, money facilitates to determine the share of each factor should receive and all these distributions are done through the medium of money.
(iv) Importance in Finance : The government plays a predominant role in the functioning as a welfare economy. The government receives its income in the form of taxes, fees, prices, etc. and utilises this income for administrative and development purposes. Without money, the administrative welfare and development functions of a modern-economy and its welfare would become difficult, if not impossible.
(v) Indicator of econonic development: It is an accepted to money facilitates and motivates all economic activities in a country. economic development is measured in terms of money. The type of by a country determines the extent of economic development of a powerful instrument for capital formation both in the developed as well as in developing countries of the world. The importance o money can be better understood in the following words of G. Crowther, “Every branch of knowledge has its fundamental discovery, similarly, in economics in the whole commercial side of man’s existence, money is the essential invention on which all the rest is based.”
(vi) Importance in social sector : The primary social goals for a welfare evaluation of the operation of an economic system might be the maximum freedom of choice for individuals, an equitable distribution of income and optimum standards of living for all individuals as determined by their preferences and restricted only by available resources and technology. The goal of a welfare economy can be achieved by only in a money economy.
(vii) Importance in exchange: As a medium of exchange money removes all the difficulties of barter. With the introduction of money exchange, commodities are now exchanged through money which helps in buying and selling goods and services freely at all stages of development. Today the currency of almost all the countries is available in all denominations and it enables to do the smallest of the small purchases quite conveniently. The double coincidence of wants between two individuals is no longer necessary. The value can now be measured easily and quickly. No difficulty is experienced in storing purchasing power.
(viii) Importance in other sectors: In addition to the social and economic sectors, money is the measuring rod of development and success in other fields also. Monetary rewards to the players, artisans, writers etc. are the incentives for their good work and future success.
The use of money obviates, at one sweep, all the obstacles arising from space and time. For another purpose, money brings up to the surface all the price relationship in all their entity which leads to optimum utilisation of resources. In other words, all that money does in a growth process is that it provides “an efficient payment mechanism” and guides ‘qualitatively and quantitatively the flow of funds to economic units whose aggressive spending is stimulating real output and the flow of financial assets to economic units whose restraint on spending frees resources for real investment.”
Money Notes Study Material
DETERMINATION OF VALUE OF MONEY
The meaning of value of money is the ‘exchange of money.’ Money is not desired for its own sake. It is desired because it has purchasing power with which goods and services can be bought. The exchange value of a good is expressed as the quantity of other goods which must be exchanged to obtain one unit of the given good. The utility of money is derivative. It is solely derived from its exchange value from the utility of the things which it can buy. The value of money lies not in its direct utility, but in its buying capacity.
A necessary condition for the equilibrium of the value of the money is that the supply of money should be equal to the demand for money. The demand for money within a specified area at a given period is merely the sum of individual demand for money to hold. The supply of money refers to the stock of money held by the public in spendable form. Money supply with the public enterprise or the privately held money supply comprises private holdings of the currency and the demand deposits held by public in banks. Currency is issued by the central government or the central bank in the form of paper notes and coins. It is legal tender money and, therefore, enjoys general acceptability as a means of payments. In a developed economy, demand deposits of banks are the most important component of the money supply. Demand deposits can be drawn upon by cheques without any prior notice or permission and without any risk of lose to the depositors. If we have to estimate the total supply of money over a period of time, we have to include the velocity of money during that period. The average number of times money is transferred between individuals, business firms and others in a given period of time is the velocity of circulation of money. It includes every transfer whether in connection with consumers purchase, producers purchases or financial transactions. The value of money is also determined by the interaction of demand for and supply of money. If the supply of money increases, its purchasing power reduces and it is the state of inflation. Increase in money supply unaccompanied by a proportionate increase in the output of goods and services is termed as inflation.
GENERAL PRICE LEVEL AND VALUE OF MONEY
It should be noted that the value of money cannot be determined or indicated in terms of any single commodity or a group of some commodities. It is expressed in the form of all the commodities that can be purchased by it. It refers to the general purchasing power of money, i.e., the amount of goods and services in general which a unit of money can purchase at a particular time. According to Robertson, therefore, by value of money, “We mean the amount of things in general which will be given in exchange for a unit of money.” The value of money is closely related with the prices of goods and services. It is in the fact, the reciprocal of the level of prices. When the price level is high, the value of money or ability of each unit to purchase goods and service is low and viceversa. In view of the fact that there are innumerable commodities and innumerable prices in the world, to express the value of money in terms of all things or all prices taken together is neither feasible nor useful. This difficulty is overcome by taking into consideration the general level of prices. By averaging prices of all commodities, like and unlike, important and unimportant, we might get a fairly accurate idea of the value of money. A rise or fall in the general price level does not mean that the price of each and every commodity has risen or fallen in the same proportion. In fact, the general price level denotes the central tendency of a group of prices. Thus, general price level is indicative of general or average tendency of prices.
Money Notes Study Material
ASSUMPTION OF QUANTITY THEORY OF MONEY
The quantity theory of money is based on the following assumptions:
1 There is no change in the transactions under barter system.
2. Demand for money and business transactions are constant.
3. The ratio of credit money to legal tender money remains constant.
4. The velocity of circulation of money (v) remains constant.
The quantity theory of money is based on highly unrealistic assumptions. The factors which have been assumed as constant, practically do not remain constant. Each of the factors in equation of exchange is likely to can show its influence on other factors. Some reforms on other factors. Some reforms are made in quantity theory of money which are known as ‘Fisher’s equation’, ‘Cambridge reforms restatement’ of quantity theory.
CRITICISM OF QUANTITY THEORY OF MONEY
The quantity theory of money has been criticised on the following grounds:
1 The theory does not accept the importance of time lag.
2. The important factor of this theory is supply of money. It neglects the demand for money.
3. This theory offers a long run analysis of money. It ignores the short period.
4. The theory measures only cash transactions.
5. The theory assumes that the changes in the price level are the outcome of changes in the supply of money. This assumption is unrealistic.
6. The theory fails to explain the cyclical movements of prices and production.
7. According to the critics, the equation is worthless mathematical truism.
8. The quantity theory of money is based on unrealistic assumptions.
Inspite of the above criticism, the theory is not completely false. The quantity theory of money is not totally useless. The validity of theory has been brought out in innumerable instances when large issues of money have pushed up prices to unprecedented levels. The monetary policy has always aimed at controlling prices through management and regulation of the volume of money in the country. The rapid rise in prices in India in recent years is also associated with a substantial increase in the supply of money. The presumption in all modern theories is that a continued rise in money supply will definitely tend to raise prices. But it is not established by the experience that price variations are in direct proportion to the variations in the quantity of money.
Money Notes Study Material
INCOME THEORY OF VALUE OF MONEY
The development of income approach to the explanation of the inter relationship of money, prices and economic activity has been an outstanding event in the history of monetary theory. The theory is generally ascribed to Keynes, but it roots lie deeper in a stream of thinking that has its sources for back in the history of economic ideas. In the writing of such outstanding economists as Thomas Tooke, Wick Sell, Afalion, Schumpter, Hawtrey, Robertson and many others it has been elaborated and discussed to such an extent that it now occupies a dominant position in the monetary analysis. The task of constructing a full-fledged theory was left for Keynes who successfully completed it in his General theory.
The income theorists conceive that the changes in demand are a result of changes in income. According to the income theory of prices, the change in the price level is not an isolated phenomenon. The income theory determines the value of money with the help of identity between total money income and total money expenditure on consumption goods and capital goods, The flow of money income has generated a flow of real income (goods and services, and the value of money, therefore, depends upon the relative strength of the flow of money income and the flow of real income. The total income of a community is equal to its total expenditure on consumer goods and capital goods. Each expenditure in the community creates some income which is again spent and creates another income and so forth the cycle goes on. If this circular flow is disturbed, there will be Tuctuations in income output, employment and prices. It is the flow of income in relation to expenditure which determines the price level. In Keynes’s opinion, changes in the level of income and expenditure brings changes in the relation between savings and investments. In his opinion a change in the relationship between the aggregate savings and investments brings about a change in the level of income, and expenditure and finally results in changing the price level.
According to Keynes, aggregate expenditure consists of expenditure on consumption goods and on capital goods. The aggregate outlays consist the income flow because all outlays or money expenditures (E) on consumption goods and capital goods (investment outlays) equal the sum of money income (y) received in that period, i.e., E = Y.
Thus,
Y = C+S Y = Total yield
Y =C+I C = Consumption
I = Y-S I = Investment
S = Y-I S = Saving
C+S =C+I
Therefore, S = I
Thus, savings and investments in the statistical sense are always equal by definition. Investment is that part of current output which is in excess of the value of consumption goods. Saving is the excess of income over expenditure for consumption. Therefore, investment must be equal saving since they are both equal to the excess of equal values over consumption. Keynes holds that if saving is equal to investment exceeds saving (I >S), both income and expenditure will rise, rising at the same time the level of employment and prices. If saving exceeds investment (S > I), both income and price will decline.
Money Notes Study Material
CHARACTERISTICS OF SAVING AND INVESTMENT THEORY OF MONEY
The income-expenditure approach or saving-investment theory marks a distinct improvement over the quantity theory of money. Its main merits are given below:
1 The assumption of under employment underlying this theory is more appropriate and realistic than the assumption of full employment implicit in the quantity theory of money.
2. The income theory is more scientific as compared to the quantity theory of money.
3. Income theory is by far the most useful approach available for analyzing the monetary aspects of business cycle.
4. The income theory is easy to understand.
5. The saving-investment theory also throws a spotlight on the velocity of circulation of money.
6. The theory marks a distinct improvement on the quantity theory in so faras it can explain the cyclical rise and fall in prices.
Aforesaid analysis makes it clear that the income theory of value of money is improvement over the quantity theory of money. The relationship between saving and investment, as analysed in the income theory, pertains only to the short period fluctuations of employment and prices. In the long run phenomenon, at full employment stage, the quantity theory is perfectly granted. It ma admitted that prices can rise in a boom without any proportional increas supply of money, but they cannot move to a permanent higher level unless they are supported by a permanent increase in the supply of money. Crowther has rightly remarked, “The quantity theory of money explains, as it were, the average of the sea; the savings and investments theory explains the violence of the tides.
While the quantity theory gives importance to monetary policy, the income theory gives emphasis to fiscal policy of taxation, public expenditure and public debt management.
Money Notes Study Material
EXERCISE QUESTIONS
Long Answer Questions
1 Explain the meaning and importance of money.
2. Define money and explain its functions and importance.
3. Explain saving and investment theory of money. Is it necessary to improve quantity theory of money?
4. “Money is what money does.” How far is this definition of money suitable?
5. “The importance of money essentially flows from its being a link between the present and future,” Discuss the statement.
6. Explain the functions of the money in the Indian economy. Can money alone perform them?
7. “The importance of money essentially flows from its being a link between the present and future.” Discuss the statement.
Short Answer Questions
1 What do you understand by money?
2. Define money.
3. What is quantity theory of money?
4. Write the characteristics of saving and investment theory of money.
Objective Questions
(I) Select the correct alternative:
1 The income theory of money is improvement over :
(a) savings
(b) investments
(c) quantity theory
(c) none of these
2. No change in the velocity of circulation of money is the:
(a) assumption of the quantity theory
(b) assumption of savings
(c) assumption of investment
(d) all of above
3. Price determination of commodity is the function of money :
(a) contingent function
(b) primary function
(c) secondary function
(d) all above
4. Difficulties of barter system led to the introduction of:
(a) money
(b) price
(c) investment
(d) none of these
5. Money is the medium of:
(a) price
(b) exchange
(c) saving
(d) all of above
[Ans: 1. (c), 2. (a), 3. (b), 4. (a), 5. (b)]
(II) Write True or False :
1 Modern business is not attributed to credit.
2. The money has helped the transfer of value from one person to another and from one place to another because of its easy transferability and general acceptability.
3. Money serves as the unit in terms of which the value of all goods and services is measured and expressed as a ‘price.’
4. The medium of exchange function can be served by anything which is generally or commonly accepted by people in exchange for goods and services.
[Ans: 1. False, 2. True, 3. True, 4. True]
Money Notes Study Material
(III) Fill in the Blanks :
1 The ………………. is the prominent determinant of the supply of money in the economy.
2. Deficit financing will definitely cause an expansion of currency which in turn may result in considerable expansion in.
3. The ……………… serve as a basis for expansion of credit by banks and therefore, for the creation of derived deposits.
4. …………… implies a positive Endeavour on the part of the central bank to regulate the volume of bank credit.
(Ans: 1. Central bank, 2. Money supply, 3. Primary deposit, 4. Credit control]
