Functions of Money – Types of Money
🟠 Topic 45: Functions of Money – Types of Money
📌 Introduction
Money is a fundamental element in any economy, acting as the medium of exchange, store of value, and unit of account. From barter systems to digital currencies, the concept of money has evolved to support increasingly complex economic systems. Understanding the functions and types of money is crucial for comprehending monetary policy, banking, and economic growth.
🔹 What is Money? 💰
📖 Definition
Money is anything that is universally accepted as a medium of exchange, measure of value, store of value, and standard of deferred payment.
📊 Evolution of Money
| Stage | Form of Money |
|---|---|
| Barter System | Direct exchange of goods & services |
| Commodity Money | Gold, silver, grains |
| Metallic Money | Coins made from precious metals |
| Paper Money | Currency notes issued by central banks |
| Bank Money | Deposits in banks used for transactions |
| Digital Money | UPI, e-wallets, cryptocurrencies |
🔹 Functions of Money
1️⃣ Medium of Exchange
- Facilitates buying and selling of goods & services.
- Eliminates the double coincidence of wants in barter.
- Ensures smooth functioning of trade and commerce.
Example: Buying groceries using cash or UPI.
2️⃣ Measure of Value (Unit of Account)
- Acts as a common measure for valuing goods and services.
- Allows comparison of prices across products and services.
- Provides a numerical value to economic activities.
Example: A car is worth ₹10 lakh and a bike ₹1 lakh — both values expressed in money.
3️⃣ Store of Value
- Preserves purchasing power over time.
- Allows individuals to save wealth in the form of money.
- However, inflation can erode the value over time.
Example: Keeping savings in a bank account.
4️⃣ Standard of Deferred Payment
- Enables contracts and credit transactions.
- Facilitates lending and borrowing.
- Ensures that obligations can be settled in the future.
Example: Loans repaid in installments using money.
🔹 Types of Money
1️⃣ Commodity Money
- Intrinsic value derived from the material itself.
- Historically used in ancient economies.
Examples: Gold coins, silver bars, salt, cattle.
✔️ Advantages: Value backed by physical commodity.
❌ Disadvantages: Difficult to store, transport, and divide.
2️⃣ Fiat Money
- Declared as legal tender by the government.
- No intrinsic value, derives value from trust in issuing authority.
Examples: Indian Rupee (INR), US Dollar (USD).
✔️ Advantages: Easy to produce, flexible supply.
❌ Disadvantages: Can be devalued by inflation if mismanaged.
3️⃣ Fiduciary Money
- Money whose value depends on trust and acceptance.
- Issued by commercial banks and backed by promises.
Examples: Cheques, promissory notes.
✔️ Advantages: Facilitates credit expansion.
❌ Disadvantages: Not universally accepted like cash.
4️⃣ Commercial Bank Money (Deposit Money)
- Created by commercial banks through the credit creation process.
- Exists as digital entries in bank accounts.
Examples: Bank deposits, online transfers.
✔️ Advantages: Convenient for large transactions.
❌ Disadvantages: Dependent on banking system’s stability.
5️⃣ Near Money
- Highly liquid financial assets that are easily convertible to money.
- Not directly used for transactions.
Examples: Fixed deposits, treasury bills.
✔️ Advantages: Safe store of value.
❌ Disadvantages: May have conversion time lag.
6️⃣ Digital Money
- Exists only in electronic form.
- Facilitated by bank accounts, e-wallets, digital platforms.
Examples: UPI, Paytm balance, cryptocurrencies.
✔️ Advantages: Instant transfer, low cost.
❌ Disadvantages: Dependent on internet infrastructure.
7️⃣ Cryptocurrency
- Decentralized digital currency, not issued by any central authority.
- Relies on blockchain technology.
Examples: Bitcoin, Ethereum.
✔️ Advantages: Global transactions, tamper-proof.
❌ Disadvantages: Volatile, regulatory uncertainty.
🔹 Characteristics of Good Money
| Characteristic | Explanation |
|---|---|
| Acceptability | Universally trusted and accepted |
| Durability | Long-lasting without degradation |
| Divisibility | Can be divided into smaller units |
| Portability | Easy to carry and transport |
| Uniformity | All units of money are identical |
| Stability of Value | Maintains purchasing power over time |
🔹 Role of RBI in Money Supply
- RBI manages the supply of currency notes.
- Regulates credit creation by commercial banks.
- Ensures monetary stability through policy tools (Repo, CRR, SLR).
🔹 Case Study – Demonetisation (2016)
- High-value notes (₹500 & ₹1000) demonetised to: ✔️ Curb black money.
✔️ Encourage digital payments.
✔️ Formalise the economy. - Resulted in a short-term cash crunch, followed by a boom in digital transactions.
🔹 Modern Trends in Money & Payments
| Trend | Example |
|---|---|
| UPI & QR Payments | Digital money replacing cash |
| Central Bank Digital Currency (CBDC) | RBI’s Digital Rupee pilot |
| Cryptocurrency Regulations | Global push for stablecoins regulation |
| Fintech Integration | Lending, wealth management via apps |
Key Statistics (2023)
| Indicator | Value |
|---|---|
| Currency in Circulation (INR) | ₹32 lakh crore |
| UPI Transactions (2023) | ₹139 lakh crore |
| Digital Rupee Pilots | Retail & Wholesale Launched |
📚 Practice MCQ
1️⃣ Consider the following statements regarding Fiat Money:
- It has intrinsic value.
- It is declared legal tender by the government.
- Its value is based on trust in the issuing authority.
Which of the above statements are correct?
✅ Options:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2, and 3
2️⃣ Which type of money has value based on the underlying material itself?
✅ Options:
(a) Fiat Money
(b) Commodity Money
(c) Fiduciary Money
(d) Digital Money
3️⃣ Which of the following is an example of near money?
✅ Options:
(a) Gold coin
(b) Bank cheque
(c) Treasury bill
(d) Cryptocurrency
