Money – Definition

Economics SSS 1 Third Term

WEEK 5

Money – Definition

Performance Objectives

Student should be able to:

1. Explain the meaning of money
2. Identify the various types of money and the functions of money

1. Explain the characteristics of money.

Content

Definition of Money

Money is anything that is generally accepted as a medium of exchange and in the settlement of debts. Money is anything that is generally accepted as a means of payment. Money is primarily a medium of exchange or means of exchange. It is a way for a person to trade what he has for what he wants. It is a medium of exchange, a store of value and a unit of account. It is used to pay debts, purchase goods and services and is accepted by the government for taxes. The term medium of exchange is used to describe money’s ability to settle debts and to increase the purchasing power of individuals. Money derives its power and value from being the legal tender that is accepted as a universal method of payment within the boundaries of each country or an economy. Legal Tender laws are enacted to require people to use the government’s money in payment of lawful debts among private citizens. Money supply is the form in which money is available in the economy. It can be in the form of currency or bank money. Currency is described as the physical nature of money supply in an economy. It is grouped into coins and banknotes. Coins were the earliest forms of currency after barter trade and were later followed by notes.

Historical development of money

In early ages, humans mainly subsisted nomadically or by hunting and gathering food. However, difficulties with storing things of value, a hindrance to free movement, and the limitations imposed by their natural environment compelled them to trade for those goods and services they could not provide for themselves, especially once populations began to grow and settle in fixed locations. This led to the development of the barter system.

The Barter System:

Barter is the exchange of one item for another. For instance, in the olden days, a Brahmin would exchange his services to provide knowledge in exchange for a certain quantity of rice, or a farmer may exchange his excess wheat production for a cow to satisfy his future need to plough his field. In both these examples, no money changes hands.

Barter is the oldest way of conducting business and predates the use of coins and paper money. Historians have traced the origins of barter in settlements in the Middle East, Greece and Turkey, in addition to many other parts of Asia and Africa between 8000 BC and 6000 BC. Barter survives in present days in some places in the world.

The barter system works well as long as people have goods that other people need and vice-versa. However, a few problems are inherent to the system. What if a person or a community had a surplus of something to trade that no one else wants? What if the terms for a fair transaction cannot be agreed upon?

These limitations of barter trade probably became more evident as communities started to interact with each other over greater distances and a network of trade routes sprang up to link great civilizations. The quantum of exchange in barter was hard to determine as it varied with different counterparties and between different regions.

The Development of Currency:

To overcome the problems faced by barter, the great early civilizations gradually developed alternative means of exchange. Commonly used and regularly demanded barter commodities, such as wheat, were standardized into weights and measures which, in turn, helped value other goods and services.

However, the use of such commodities as a ‘medium of exchange’ was still limited by the high cost of transporting them and the risk of perishability. This led to a need for a standardised ‘medium of exchange’, which could be transported easily and accepted across civilizations to buy or sell other goods. This gradually-developed medium of exchange came to be known as ‘currency’ or ‘money’.

Around 1200 BC, cowries’ shells were first used as a medium of exchange in China. These shells were widely available on the shores of the Pacific and Indian Oceans, and were still used as currency in some parts of the world as recently as the middle of the twentieth century.

Historians believed that the shift from barter towards the use of currencies was a gradual one. During the transition, people haggled over how much a currency was worth in terms of goods or services. As more and more transactions were executed using currency these created a ‘database’ of allocated values to currencies as well as goods and services. In time, the use of currency as a medium of exchange became standardized and accepted.

The Earliest Coins:

It is generally believed that the Lydians were the first people to have struck metal coins around 640 BC. This information is documented by the Greek historian Herodotus in the fifth century BC. The earliest coins were made from electrum, an alloy of gold and silver.

Lydia was one of the most important sources of electrum in the ancient world, and its capital city Sardis was a major commercial centre that linked the Asian kingdoms of the East with cities surrounding the Aegean Sea. From Lydia, electrum coinage spread to the Greek cities of Asia Minor such as Byzantium, Chalcedon and Xanthus (present-day Kinik in western Turkey).

From there, it reached the Greek islands and then the mainland. But historians often find it difficult to tell where a particular coin belonged to as these early coins was not inscribed with the names of the places where they were made. Still, as coins were produced by states, rather than private individuals, their designs and inscriptions are a very rich source of information about political history, religion, and culture.

Development of Paper Money:

In China, the first time paper money emerged was after Ming dynasty (1368-1399 AD). The early development of paper money continued in Pennsylvania, in 1764; and by the government of the United States from 1837 to 1863. The Continental Congress Currency Notes, 1779, typical issues to finance the revolution. First penny note issued by first United States Chartered Bank in 1 789.

The Development of Banking:

Historians concur that early banking started in Italy whereby the end of the sixteenth century, moneychangers and goldsmiths started releasing loans from their customer deposits. This technique of depository lending supported industrial and societal growth by releasing funds, which would otherwise have remained unused in lockers and coffers.

It also increased the amount of money in circulation. The lenders had to be careful with how much they loaned as they simultaneously had to maintain the confidence of their depositors. This led to their maintaining a certain proportion of deposits as reserves.

In ancient times, temples too regularly functioned as banks. They were viewed as the safest places to store gold as their sacred status reduced the risk of theft and looting. Although there are no historical records that show where and when loans began, there are records of loans being made by temple priests to merchants in the Mesopotamian stronghold of Babylon in 1800 BC.

Large Mesopotamian temples were not only religious centres, law courts, schools, and archive depositories, but also banks and mercantile establishments. For early transactions, the role of Babylonian temples was not unlike that of state banks—they conducted their banking business with all the weight of official authority.

The temple of Shamash in Babylon was considered the most important of these early banks. Forms of lending were also evident in Roman times and monetary loans are mentioned in the Bible also.

The Development of Credit Cards and Electronic Money:

The widespread use of credit cards and electronic money as fundamental components of international fund transfers occurred towards the last quarter of the twentieth century.

Electronic money can be defined as a payment instrument whereby monetary value is electronically stored on a technical device in the possession of the customer. The amount of stored monetary value is decreased or increased, as appropriate, whenever the owner of the device uses it to make purchase, sale, loading or unloading transactions.

Trade by Barter and its Limitations

Trade by Barter may be defined as a form of trading in which goods are exchanged directly for other goods without the use of money as a medium of exchange. For example, if someone has rice and needs beans, he must locate somebody who has beans and needs rice. Trade by Barter has many setbacks.

Problems or Disadvantages of Trade by Barter

1. Problems of Double Coincidence of wants: This involves looking for someone who needs what you have and at the same time has what you need. To do this amounts to a very serious problem.

2. No Fixed rate of Exchange: There is the problem of exchange rate determination between two products. Different rates of exchange have to be determined to cover every transaction before it can take place, e.g. how much of apples can you exchange for Rice.

3. Wastage of Time and Effort: Barter system leads to a waste of time and energy because one has to search for somebody to exchange the goods with.

4. Problems of Indivisibility: Many goods cannot be divided into small convenient units because they are heavy and indivisible so it does not encourage divisibility.

5. Problems Created by Bulkiness of some Goods: Some of the good to be exchanged are so bulky that one finds it difficult to carry them about.

6. No Room for Deferred Payment: In Trade by Barter, there is no room for deferred payment. One cannot collect certain goods and hope to pay another day. Barter requires immediate settlement.

7. It Discourages Borrowing and Lending: Borrowing and lending under trade by barter is practically impossible as there is no standard unit of measurement.

8. It Discourages Large Scale Production: As a result of the difficulties in the system of exchange by barter, it, therefore, leads to people producing goods only for themselves and that of their immediate family. In other words, Trade by barter encourages self-sufficiency hence it limits specialization of labour.

9. Difficulty in Storing Wealth: The barter system, unlike money, does not encourage the storage of wealth. It is difficult to store wealth or value, especially where perishable goods like fresh tomatoes and onions are involved.

Functions of Money

Money performs the following functions:

1. Medium of Exchange: Money can serve as a medium through which money can exchange goods and services. Money can be used to buy a different variety of goods and services. This facilitates the means of exchange. It came into use as a result of the inadequacies of the barter system. Money is therefore widely accepted as payment for debts.

2. Standard of Deferred Payment: Since money can be stored, it can be accumulated to pay debts that are fixed in terms of money. Money can serve as a medium by which business transactions on credit can be settled in the future. The use of money makes it possible for payments to be deferred from the present to some future date.

3. Unit of Account: In serving as a unit of account, it becomes practically possible for individuals and companies to keep accounting record of their transactions in bank statements, ledgers and invoices.

4. Store of Value: Money is a good store of value because wealth can be stored for future use. When there is no inflation, money stored or saved retains its value for many years.

5. As a Measure of Value: The values of goods and services are expressed by prices, therefore money is used as a yardstick to measure and compare the worth of goods and services as well as occupation.