Money and Banking

Definition of Money

Money is anything that is generally accepted as a medium of exchange, a store of value, and a unit of account. It facilitates transactions and reduces the costs of exchange.

Historically, money has taken various forms, including commodity money (e.g., gold, silver), representative money (e.g., paper money backed by gold), and fiat money (e.g., paper money not backed by any commodity).

Functions of Money

1. Medium of Exchange

Money is widely accepted for buying goods and services. This eliminates the need for barter, which requires a double coincidence of wants.

2. Store of Value

Money can be held and used at a later time. While inflation can erode the purchasing power of money over time, it generally retains its value.

3. Unit of Account

Money provides a common measure of value, allowing for easy comparison of the prices of different goods and services. This simplifies accounting and economic decision-making.

Characteristics of Money

1. Liquidity

Money is highly liquid, meaning it can be easily converted into goods and services without loss of value.

2. Portability

Money is easily carried and transferred.

3. Divisibility

Money can be divided into smaller units without losing its value.

4. Durability

Money is durable and can withstand wear and tear.

5. Uniformity

All units of money are of uniform quality and value.

6. Scarcity

The supply of money is limited, which helps maintain its value.

Characteristic	Description
Liquidity	Easily convertible into goods and services.
Portability	Easy to carry and transfer.
Divisibility	Can be divided into smaller units.
Durability	Resistant to wear and tear.
Uniformity	All units have the same value.
Scarcity	Limited supply to maintain value.

Types of Money

Different forms of money exist, each with varying degrees of liquidity and acceptance.

• Commodity Money: Money with intrinsic value (e.g., gold, silver).
• Representative Money: Money whose value is derived from a commodity (e.g., paper money backed by gold).
• Fiat Money: Money declared by a government to be legal tender, not backed by a commodity (e.g., most modern currencies).
• Credit Money: Money created by banks through lending (e.g., bank deposits).

The money supply is a crucial macroeconomic variable, and its management by central banks significantly impacts economic activity.