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TOPIC 4: MONEY
Money
The Historical Background of Money
Expalin the historical background of money
Commerce plays a fundamental role in the satisfaction of human wants. In primitive societies, the producers themselves were the consumers. Hence; they were compelled to provide themselves with foods, shelter and clothes. Under such circumstances, the question of commercial transactions or exchange of goods and services did not arise. But slowly heir wants started to increase in size and in number. They were no longer able to satisfy all their wants, so they began exchanging he commodities produced with those produced by others.
Meaning of the Term "Barter System"
Define the term "barter system"
The exchange of goods for goods was known as barter system of trade. However, barter trade could not persist for a long period of time due to the following demerits:
Merits and Demerits of "Barter System"
Point out merits and demerits of "barter system"
DEMERITS OF BARTER SYSTEM.
- Lack of Double Coincidence of Wants: Barter transactions can be possible only when two persons desiring exchange of commodities should have such commodities which are mutually needed by each other. For example, if Fatma wants cloth, which Tully has, then Fatma should have such commodity which Tully wants. In the absence of such coincidence of wants, there will be no exchange. However, it is very difficult to find such persons where there is coincidence of wants. One had to face such difficulties in barter economy because of which this system had to be abandoned.
- Indivisibility of some commodities: The second difficulty of barter exchange relates to the exchange of such commodities which cannot be divided. For example, a person has a cow and he wants cloth, food grains and other items of consumption. Under such a condition, exchange can be possible only when he discovers a person, who is in need of a cow and has all such commodities, but it is very difficult to get such a person. Then how to affect the exchange.Similarly the second problem relates to the exchange of such commodities which cannot be divided into pieces, because in this kind of situation, a big commodity like cow cannot be divided into small pieces for making payment of the goods of smaller value.
- Lack of a Common Measure of Value: The biggest problem in the barter exchange was the lack of common measure of value i.e., there was no such commodity in lieu of which all commodities could be bought and sold. In such a situation, while facilitating the exchange of a commodity its value was to be expressed in all commodities, such as one yard cloth is equal to ½ kilogram of potato etc. It was a very difficult proposition and made exchange virtually impossible. Now, with the discovery of money, this difficulty has been totally eliminated.
- Lack of Store of Value: In a barter economy, the store of value could be done only in the form of commodities. However, we all know that commodities are perishable and they cannot be kept for a long time in the store. Because of this difficulty, the accumulation of capital or store of value was very difficult and without the accumulation of capital, economic progress could not be made. It is because of this reason that as long as barter system continued, significant progress was not made in the world anywhere.
MERITS OF BARTER SYSTEM
- The risk of theft is lower in barter system than the risk of using money. Almost all modern forms of money can easily be stolen and are more vulnerable to theft than commodities.
- The value of commodities tends to be stable over a long period of tme, unlike the value of money which depreciates in value after a certain period of time. Due to depreciation in value, money plays little role as a future store of value.
- Barter trade is very useful in non-monetary economies, where money is too scarce to be used as a medium of exchange. For example, in rural areas barter trade is widely applied due to scarcity of money.
Meaning of "Money"
Give a definition of "money"
Money is anything which is generally acceptable as a medium of exchange and acts at the same time as a measure of value and store of value. OR Money is anything which is generally acceptable to used as a means of settling debts.
Qualities of Good Money
Following are the qualities of good money:
- General acceptance. The essential quality of good money is that it should be acceptable to all, without any hesitation in the exchange for goods and services.
- Portability. It is also an important quality of good money that is should be easily transferable from one place to another for doing business and making payment. The paper money is easier to carry because it has minimum possible wait than metallic money.
- Storability; Money should be storable and it should not be depreciate with time. If the money used is perishable it will lose its value in few days. Paper money has this quality of storability.
- Divisibility; Good money is that which could be divided into small units without losing any value.
- Durability; Money should be durable. It should not lose its value with the passage of time. The gold and silver coins do not wear out quickly and quality of money remains the same.
- Economy; It is important quality of good money that it should be made economically. If there is heavy cost on issuing more money that is not good money. Good money is that has low cost and more supply. Paper money has this quality of economy able by a society as a medium of exchange and means of settling debts.
The Functions of Money
Mention the functions of money
Money is often defined in terms of the threefunctionsorservices that it provides. Money serves as amedium of exchange, as astore of value, and as aunit of account.
- Medium of exchange: Money's most important function is as a medium of exchange to facilitate transactions. Without money, all transactions would have to be conducted bybarter, which involves direct exchange of one good or service for another. The difficulty with abarter systemis that in order to obtain a particular good or service from a supplier, one has to possess a good or service of equal value, which the supplier also desires. In other words, in a barter system, exchange can take placeonlyif there is adouble coincidence of wantsbetween two transacting parties. The likelihood of a double coincidence of wants, however, is small and makes the exchange of goods and services rather difficult. Money effectively eliminates the double coincidence of wants problem by serving as a medium of exchange that is accepted in all transactions, by all parties, regardless of whether they desire each others' goods and services.
- Store of value: In order to be a medium of exchange, money must hold its value over time; that is, it must be a store of value. If money could not be stored for some period of time and still remain valuable in exchange, it would not solve the double coincidence of wants problem and therefore would not be adopted as a medium of exchange. As a store of value, money is not unique; many other stores of value exist, such as land, works of art, and even baseball cards and stamps. Money may not even be the best store of value because it depreciates with inflation. However, money is moreliquidthan most other stores of value because as a medium of exchange, it is readily accepted everywhere. Furthermore, money is an easily transported store of value that is available in a number of convenient denominations.
- Unit of account: Money also functions as a unit of account, providing a common measure of the value of goods and services being exchanged. Knowing the value or price of a good, in terms of money, enables both the supplier and the purchaser of the good to make decisions about how much of the good to supply and how much of the good to purchase.
Difference between Inflation and Deflation
Distinguish inflation from deflation
INFLATION
This is persistent increase in the general price level.
Inflation rate is a rate which price increase it is expressed in terms of percentage
- Inflation rate=price in current year-price in previous year x100 / Price in previous year
For example, if the current year price for commodity X is Tsh 200 and the base year price is Tsh 100.
- =200-100x100 / 100
- =100%
Causes of Inflation
- Excessive demand for goods and services.
- When demand for goods increase while supply remains constant it underscores a rise in price and if the rise is persistent it results in inflation.
- Shortage of goods and services.
- Increase in cost of production
- Increase in government spending
- Illegal activities such as smuggling causes artificial shortage of goods and therefore rise in the prices of goods consequently inflation occurs.
- Natural calamities.
DEFLATION
This is the persistent decrease in price level.
Causes of Deflation
- Excessive supply: when supply of goods exceeds the demand for goods it cause a decrease in prices.
- Decrease in effective demand: when the effective demand for the product declines in results to the fall in the price level.
- Decrease in the money supply: a decrease in money supply affects the purchasing power of the people and leads to the fall in the price level.
- Increase in government revenue: when the government reduces spending on expenditures such as wages, security and education it affects incomes of the people and their purchasing power consequently a fall in the prices of goods and services.
Exercise 1
QUIZ
- Money is as money does.” Discuss.
- Briefly discuss barter system.
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