• With money as a medium exchange individuals can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences.

• A buyer can buy goods through money and a seller can sell goods for money.

(b) Measure of value

• Under barter system, there was no common measure of value. Money has also solved this difficulty.

• As Geoffrey Crowther puts it, “Money acts as a standard measure of value to which all other things can be compared.” Money measures the value of economic goods.

• Money works as a common denominator into which the values of all goods and services are expressed.

• When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.

(c) Store of value

• Under barter system it is very difficult to store wealth for future use.

• Most of the goods are perishable and their storage requires huge space and transportation cost.

• Wealth can be conveniently stored in the form of money.

• Money can be stored without loss in value.

• Money can easily be stored for future use.

(d) Standard of deferred payments

• Under barter system, transactions on deferred payments are not possible.

• With money, the debtors make a promise that they will make payments on some future dates. In those situations money acts as a standard of deferred payments.

• It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.

Question - 3 : -
What is transaction demand for money? How is it related to the value of transactions over a specified period of time?

Answer - 3 : -

Transaction demand for money refers to the demand for money for meeting day to day transactional needs. As money is a liquid asset (easily acceptable or exchangeable), everyone has the tendency to hold money. People earn incomes at distinct points of time but consume throughout the entire period. So, people tend to hold money for transaction purposes.

The relationship between the value of transactions and transaction demand for money can be explained as:

The transaction demand for money in an economy (

) can be written as

= K T

Or,

= T
Or,

= T

Where,

, represents velocity of circulation of money

T = Total value oftransactions in the economy over a period of time

K isa positive fraction

= Stock of money people are willing to hold at aparticular point of time.

The transaction demand for money is positively relatedto the total value of transactions and negatively related to the velocity withwhich money is circulated.

Question - 4 : -
Why is speculative demand for money inversely related to the rate of interest?

Answer - 4 : -

People have the tendency to hold wealth by means of property, bullion, bonds, etc. A person holding bonds can confront various fluctuations in the market in the form of capital gains or capital losses. The demand for money in order to meet these speculative needs is defined as speculative demand for money. Interest rate represents the opportunity cost of holding the money. The speculative demand for money is inversely related to the interest rate. When interest rate on securities is very high then people expect interest rates to fall in future. This implies that in future bond prices will rise indicating capital gain to the bond holders. To maximise the capital gain, more people will convert their cash balances into bonds, thereby leading to a low speculative demand for money. On the contrary, when interest rates are low, people expect interest rates to rise in future, then bond prices will fall in the future, indicating capital loss to the bondholders. Hence, to minimise the capital loss, people tend to convert bonds into money, resulting in high speculative demand for money. This shows that the speculative demand for money is inversely related to the interest rate.

Question - 5 : - What are the alternative definitions of money supply in India?

Answer - 5 : -

The alternative definitions of money supply in India can be the four measures of money supply. They are explained as under:

Measures of M₁ include:

1. Currency notes and coins with the public (excluding cash in hand of all commercial banks) [C]

2. Demand deposits of all commercial and co-operative banks excluding inter-bank deposits. (DD),

Where demand deposits are those deposits which can be withdrawn by the depositor at any time by means of cheque. No interest is paid on such deposits.

3. Other deposits with RBI [O.D]

M₁ = C + DD + OD Where, Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi-government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetaiy Fund, the World Bank, etc.

Measures of M₂

M₁[C + DD + OD]
Post office saving deposits

Measures of M₃

M₁
Time deposits of all commercial and co-operative banks.

Where, Time deposits are the deposits that cannot be withdrawn before the expiry of the stipulated time for which deposits are made. Fixed deposit is an example of time deposit.

Measures of M₄

M₃
Total deposits with the post office saving organization (excluding national savings certificates).

Question - 6 : - What is a ‘legal tender’? What is ‘fiat money’?

Answer - 6 : -

1. Legal tender:

(a) Legally, money is anything proclaimed by law as a medium of exchange.

(b) Paper notes and coins (together called currency) is money as a matter of law.

2. FIAT Money: It is defined as a money which is under the ‘FIAT’ (order/authority) of the government to act as a money.

Question - 7 : - What is High powered money?

Answer - 7 : -

It is money produced by the RBI and the government. It consists of two things:

currency held by the public and
Cash reserves with the banks.

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