Meaning of money:

Economists define “Money (also referred to as the money supply) as anything that
is generally accepted in payment for goods or services or in the repayment of
debts”.

Economists make a distinction between money in the form of currency, demand

deposits, and other items that are used to make purchases and wealth, the total
collection of pieces of property that serve to store value.

Functions of money:

1. Medium of exchange
2. Unit of account
3. Store of Value

Medium of exchange:
In almost all market transactions in our economy, money in the form of currency or
checks is a medium of exchange; it is used to pay for goods and services. The use
of money as a medium of exchange promotes economic efficiency by minimizing
the time spent in exchanging goods and services.

The time spent trying to exchange goods or services is called a transaction cost. In
a barter economy, transaction costs are high because people have to satisfy a
“double coincidence of wants”—they have to find someone who has a good or
service they want and who also wants the good or service they have to offer.

For a commodity to function effectively as money, it has to meet several

criteria:

 It must be easily standardized, making it simple to ascertain its value;

  It must be widely accepted;
 It must be divisible, so that it is easy to “make change”;
 It must be easy to carry; and
 It must not deteriorate quickly.

Unit of account:
The second role of money is to provide a unit of account; that is, it is used to mea-
sure value in the economy. We measure the value of goods and services in terms of
money, just as we measure weight in terms of pounds or distance in terms of miles.

Imagine how hard it would be in a barter economy to shop at a supermarket with

1,000 different items on its shelves and be faced with deciding whether chicken or
fishis a better buy if the price of a pound of chicken were quoted as 4 pounds of
butter and the price of a pound of fish as 8 pounds of tomatoes. To make it possible
to compare prices, the tag on each item would have to list up to 999 different
prices, and the time spent reading them would result in very high transaction costs.
The solution to the problem is to introduce money into the economy and have all
prices quoted in terms of units of that money, enabling us to quote the price of
economics lectures, peaches, and movies in terms of, say, dollars. using money as
a unit of account lowers transaction costs in an economy by reducing the number
of prices that need to be considered. The benefits of this function of money grow
as the economy becomes more complex.

Store of Value
Money also functions as a store of value; it is a repository of purchasing power
over time. A store of value is used to save purchasing power from the time income
is received until the time it is spent.
Money is not unique as a store of value; any asset—whether money, stocks, bonds,
land, houses, art, or jewelry—can be used to store wealth. Many such assets have
advantages over money as a store of value: They often pay the owner a higher
interest rate than money, experience price appreciation, and deliver services such
as providing a roof over one’s head. If these assets are a more desirable store of
value than money, why do people hold money at all?
The answer to this question relates to the important economic concept of liquidity,
the relative ease and speed with which an asset can be converted into a medium of
exchange. Liquidity is highly desirable. Money is the most liquid asset of all
because it is the medium of exchange; it does not have to be converted into
anything else to make purchases. Other assets involve transaction costs when they
are converted into money.

Types of money {evolution of the payments system}

1) Commodity Money
2) Fiat Money
3) Checks
4) electronic Payment
5) e-Money

Commodity Money

Money made up of precious metals or

another valuable commodity is called commodity money, The problem with a
payments system based
exclusively on precious metals is that such a form of money is very heavy and is
hard to transport from one place to another. Imagine the holes you’d wear in your
pockets if you had to buy things only with coins! Indeed, for large purchases such
as a house, you’d have to rent a truck to transport the money payment.

Fiat Money

Fiat money, paper currency decreed by governments as legal tender (meaning that
legally it must be accepted as payment for debts) but not convertible into
coins or precious metal.

Checks
A check is an instruction from you to your bank to transfer money from your
account to someone else’s account when she deposits the check.

Advantages:

1) With checks, payments that cancel

each other can be settled by canceling the checks, and no currency need be
moved.
2) Reduces the transportation costs associated with the payments sys-
tem and improves economic efficiency.
3) Another advantage of checks is that they can be written for any amount up to
the balance in the account, making transactions for large
amounts much easier.

Disadvantages:

1) It takes time to get checks from one place to another,

2) The paper shuffling required to process checks is costly;

Electronic Payment
The development of inexpensive computers and the spread of the Internet now
make it cheap to pay bills electronically now banks provide websites at which you
just log on, make a few clicks, and thereby transmit your payment electronically.
Not only do you save the cost of the stamp, but paying bills becomes (almost) a
pleasure, requiring little effort.

E-Money
Electronic payments technology can substitute not only for checks but also for
cash, in the form of electronic money (or e-money)—money that exists only in
electronic form.

1. The first form of e-money was the debit card.

2. A more advanced form of e-money is the stored-value card. The simplest
form of stored-value card is purchased for a preset dollar amount that the
consumer pays up front, like a prepaid phone card. The more sophisticated
stored-value card is known as a smart card.
3. A third form of electronic money is often referred to as e-cash, which is
used on the Internet to purchase goods or services.

Function of financial markets:

Financial markets perform the essential economic function of channeling funds

from households, firms, and governments that have saved surplus funds by
spending less than their income to those that have a shortage of funds because they
wish to spend more than their income.

Securities are assets for the person who buys them but liabilities (IOUs or debts)
for the individual or firm that sells (issues) them.
 Function of capital market:

The primary role of the capital market is to raise long-term funds for governments,
banks, and corporations while providing a platform for the trading of securities.

Capital markets help to channelize surplus funds from savers to institutions which
then invest them into productive use. Generally, long-term securities take place in
this market. The capital market is bifurcated in two segments, primary market and
secondary market:

a) Primary Market: Otherwise called as New Issues Market, it is the market

for the trading of new securities, for the first time. It embraces both initial public
offering and further public offering. In the primary market, the mobilization of
funds takes place through prospectus, right issue and private placement of
securities.

b) Secondary Market: Secondary Market can be described as the market for

old securities, in the sense that securities which are previously issued in the
primary market are traded here. The trading takes place between investors that
follows the original issue in the primary market. It covers both stock exchange and
over-the counter market.

Capital Market Instruments

Capital market instruments are debt and equity instruments with maturities of
greater than one year.

1. Stocks

Stocks are equity claims on the net income and assets of a corporation.
 2. Mortgages and Mortgage-Backed Securities

Mortgages are loans to households or firms to purchase land, housing, or other real
structures, in which the structure or land itself serves as collateral for the loans.

mortgage-backed securities, a bond-like debt instrument backed by a

bundle of individual mortgages, whose interest and principal payments are
collectively
paid to the holders of the security.

3. Corporate Bonds

These long-term bonds are issued by corporations with very strong credit ratings.

4. U.S. Government Securities

These long-term debt instruments are issued by the U.S. Treasury to finance the
deficits of the federal government.

5. U.S. Government Agency Securities

These long-term bonds are issued by various government agencies such as Ginnie
Mae, the Federal Farm Credit Bank, and the Tennessee Valley Authority to finance
such items as mortgages, farm loans, or power generating equipment.

6. State and Local Government Bonds State and local bonds

, also called municipal bonds, are long-term debt instruments issued by state and
local governments to finance expenditures on schools, roads, and other large
programs.
 7. Consumer and Bank Commercial Loans

These loans to consumers and businesses are made principally by banks but, in the
case of consumer loans, also by finance companies

TRADE CYCLE

Trade cycles refer to regular fluctuations in the level of national income.  It is a

well-observed economic phenomenon, though it often occurs on a generally
upward growth path and has a variable time span, typically of three years.

In trade cycles, there are upward swings and then downward swings in
business.  The periods of business prosperity alternate with periods of
adversity.  Every boom is followed by a slump, and vice versa.  Thus, the trade
cycle simply means the whole course of trade or business activity which passes
through all phases of prosperity and adversity.

Several suggestions have been put forward as to the cause of cycles.  The most
well known are developed by Samuelson, Hicks, Goodwin, Phillips and Kalecki
in the 1940s and 1950s, combine the multiplier with the accelerator theory of
investment.  More recently, attention has been paid to the effects of shocks to the
economy from technology and taste changes.

Phases of Trade Cycles:

Typically economists divide business cycles into two main phases – depression and
recovery.  Boom and slump mark the turning points of the cycles:

(a)   Depression: In this phase, the whole economy is in depression and

the business is at the lowest ebb.  The general purchasing power of the
community is very low.  The productive activity, both in the production of
consumer goods and the production of capital goods, is at a very low
level.  Business settles down at a new equilibrium point with a low level of
prices, costs and profits.  It may last for a number of years.  Following are
the characteristics of depression:

1) The volume of production and trade shrinks,

2) Unemployment increases,
3) Overall prices fall,
4) Profits and wages fall, thus, the income of the community falls to a
very low level,
5) Aggregate expenditure and the effective demand come down,
6) There is a general contraction of credit and little opportunity to
invest,
7) Stock markets show that prices of all shares and securities have
fallen to a very low level,
8) Interest rates decline all round,
9) Practically, all construction activity – whether in buildings or
machinery, comes to an end.

(b)   Recovery: This phase is also known as ‘expansion’.  The depression

period of trade cycle ends in the recovery period.  The economic situation
has now become favourable.  Money is cheap and so are the other materials
and the factors of production.  Productive activity has been increased.  The
entrepreneurs have now sufficient financial backing.  Constructional and
allied industries are receiving orders and employing more workers, thus
creating more income and employment.  This stimulates further investment
and production.  The whole economy is moving faster towards the boom.

(c)    Boom: Boom or peak is the turning point of the trade cycle.  It is the

highest point of economic recovery.  The typical features of boom are as
follows:

(i) A large number of production and trade,

(ii) A high level of employment and job opportunities in
sufficient amount to permit a good deal of labour mobility,
(iii) Overall rising prices,
(iv) A rising structure of interest rates, so that a bullish tendency
rules stock exchanges,
(v) A large expansion of credit and borrowing,
(vi) High level of investment, i.e., manufacturing or machinery
(vii) A rise in wages and profits so that the community’s income
rises, and
(viii) Operation of the economy at optimum capacity.

(d)   Recession: It is a sharp slowdown in economic activity, but it is

different from depression or slump which is more severe and prolonged
downturn.

Just as depression created the conditions of recovery, similarly, the boom

conditions generate their own checks.  All idle factors have been employed
and further demand must raise their prices, but the quality is inferior.  Less
efficient workers have to be taken on higher wages.
 Rate of interest rises and so also of the necessary materials.  The costs have
after all started the upward swing.  They overtake prices ultimately and the
profit margins are first narrowed and then begin to disappear.  The boom
conditions are almost at an end.

Then starts the downward course.  Fearing that the era of profits has come to
a close, businessmen stop ordering further equipment and materials.  The
prudent businessmen want to get out altogether and cut down his
establishment ruthlessly.  The government applies the axe mercilessly.  The
bankers insist on repayment.  The bottlenecks appear, stocks
accumulate.  Desire for liquidity all round.  This accentuates the depression.

The trade cycle is depicted in the following diagram: