Explain the functions of money in an economy.
Static Functions of money:
1. Medium of Exchange:
Money acts as a medium of exchange. In the absence of money, Barter system used to prevail (exchange of goods for goods). Its major drawback was lack of double co-incidence of wants. Without money our complicated economic system based on specialization would have been impossible.
2. A Store of Value:
Many goods and all services can’t be stored for future use. Money allows us to store purchasing power, through which we can exercise our claim on goods and services in the future.
3. A Unit of Account:
Money can be used purely for accounting purpose without any physical existence. Each and every thing needs a unit to be measured. Money acts as a measure of value. Value of all goods and services can be determined in terms of money.
4. A standard of deferred payments:
It means a payment to be made in future can be denominated in terms of money in just the same way as can a payment to be made today. Here, money is acting as a unit of account with added dimension of time.
Dynamic Functions of Money:
1. Directs Economic Trends:
Money helps in directing idle resources into productive channels and thereby affects output, employment, consumption and consequently economic welfare of the community at large.
2. Encourages Division of Labour:
In a monetary economy, people get engaged in the activity in which their productivity is maximum as they can sell additional goods and can buy the goods they want. It leads to increase in total output and increases the rate of economic growth.
3. Helps in Capital Formation:
Banks and financial institutions help in capital formation only with the help of money.
4. Bearer of options:
One who has money can utilize it for various purposes.
5. Guarantor of solvency:
Solvency implies ability of a person to oblige his debts as and when they arise. Money guarantees solvency in the sense that that has money would be sure to pay off his debts on time.
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