Evolution and Function of Money

The Barter System: Before the evolution of money, exchange was done on the basis of
direct exchange of goods and services. This is known as barter.
• Barter economy is a moneyless economy
• People produce goods either for self- consumption or for exchange with other goods
which they want.
Example: A horse may be exchanged for
A cow
Two sheep
Three goats

Difficulties of Barter System:

1. Lack of Double coincidence of wants: The functioning of the barter system requires a
double coincidence of wants on the part of those who want to exchange goods or services.
For example, suppose a person possesses a horse and wants to exchange it for a cow. In
the barter system he has to find out a person who possesses a cow and wants a horse. It is
very laborious and time consuming process.
2. Lack of a common measure of value: Another difficulty relates to the lack of a common
unit in which the value of goods and services should be measured. There being no common
measure of value, the rate of exchange will be fixed. One party is at a disadvantage in the
terms of trade.
3. Indivisibility of certain goods: It is difficult to fix exchange rates for certain goods which
are indivisible. If the man with the horse wants only two sheep, then how will he exchange
his horse for two sheep. It is impossible to divide horse.
4. Difficulty in Storing value: Under the barter system it is difficult to store value. As people
trade in cattle, grains and other such perishable commodities, it is very expensive and often
difficult to store.
5. Difficulty in making deferred payments: In a barter economy, it is difficult to make
payments in future. As payments are made in goods and services, debt contacts are not
possible due to disagreements on the part of the two parties.
6. Lack of Specialization: High degree of specialization is difficult to achieve under the
barter system. Thus no economic progress is possible in a barter economy due to lack of
specialization.

The Definition of Money:

The word “money” is derived from Greek Word “Moneta” which was the surname of
Roman Goddess.
Money: money is any good that is widely accepted for purpose of exchange, payment for
goods and services and in the repayment of debts.
M1 money:

 Known as transaction money

 Narrow definition of money supply
 Directly used for transaction
M1 =Currency held outside banks +Checkable deposit +Travelers check

Currency = paper money + coin

Checkable deposits are deposits on which checks can be written. There are different types of
checkable deposits.
M2 = M1 money
+ Savings deposit (including money market
deposit account)
+ small denominator time deposit
+money market mutual funds
Small time deposit are less than $100000
M3 = M2 money
+ Large Denominator Time Deposit
Large Denominator Time Depositor are above than $ 100000.

Functions of Money:
• Medium of Exchange: money is medium through which exchange occurs.
• Unit of Account: All goods are denominated in money.
• Store of value: Goods ability to maintain its value over time
• Standard of deferred payments: All debts are taken in money
 The Evolution of Money: There are five stages in the evolution of money.
1. Commodity money: Various types of commodities have been used as money from the
beginning of human civilization.
Hunting Society: stones, spears, skins, bows & arrows as money
Pastoral Society: used as cattle as money
Agricultural Society: used grains as money
The Romans: cattle and salt as money
The Mongolians: squirrel skins as money
Defects of commodity money:
 All commodities were not uniform in quality
 Difficult to store
 Supplies are uncertain
 Difficult to transfer from one place to another
 Commodities are indivisible.

2. Metallic Money: Metallic money took place of commodity money. Such as silver, gold,
copper, tin etc. King Midas in 8th century BC first introduced metal money. Gold coins
were used in India. Latter silver coins were used.
Defects of metallic money:
 supply is not changeable according to nations demand for internal and external use.
 Too heavy to carry
 Unsafe to carry over the long distance
 Very expensive.

3. Paper Money: The development of paper money started with Goldsmith. He gave the
depositors a receipt to return the gold on demand. Theses receipt were a substitute for
money.

4. Credit Money:
 Use of cheque as money.
 Written order to transfer money.
 cheque is different from bank notes.
 cheque is made for specific purpose

5. Near Money: Close substitute for money. Ex: Bonds, savings certificate, Treasury Bills
etc. Bank notes are issued by central bank