Introduction to the Functions of Money

Money has developed as an integral tool of our society. In its absence, any economic transaction in our society would come to a standstill. Money has established its place as the engine of the economy. In today's era, there is hardly any task that money cannot perform.

The functions performed by such an important object can be mainly divided into three parts:

1. Primary Functions

2. Secondary Functions

3. Contingent Functions

Their brief descriptions are presented as follows:

1. Primary Functions of Money

The primary functions of money refer to its fundamental roles as a medium of exchange and a common measure of value.

(a) Medium of Exchange

As a medium of exchange, money has simplified the buying and selling of goods and services in the market. Any goods, regardless of their quality, size, and quantity, can be easily exchanged with the help of money.

• It solves the problems of indivisibility of goods and storage of value of goods.

• Money helps producers to specialize in product production and provides purchasing power assurance to consumers.

(b) Measure of Value

Money acts as a standard measure in valuing goods and services in the market. Since all goods are expressed in money, it allows buyers and sellers to trade according to their needs.

• The value of all goods and services is expressed in money.

• Large indivisible goods and small goods can be valued in money, making daily transactions simple and convenient.

• Key economic indicators like per capita income, gross domestic product (GDP), gross national product (GNP), and trade balance can also be measured with money.

2. Secondary Functions of Money

The secondary functions of money, also called auxiliary or derived functions, include the following:

(a) Store of Value

Unlike barter exchange, money solves the difficulty of storing value.

• Money provides the facility to store produced goods and services for a long time by expressing them in value.

• The opportunity to convert any production into value through money and use it at any time is made possible by money.

• Money can be saved and stored for future use.

(b) Transfer of Value

The use and development of money have made it possible to convert wealth, property, or income from one form to another.

• With money, property or income can be transferred from one person to another and from one place to another.

(c) Standard of Deferred Payments

Money is a universally accepted medium that can be used for future payments.

• Commercial transactions can be expressed in money and recorded in accounts for future reference.

• In the barter system, the absence of money made credit transactions and future payments impossible.

3. Contingent Functions of Money

The contingent functions of money extend beyond its basic and secondary roles to support economic activities in broader ways:

(a) Liquidity and Uniformity in Wealth

• Individuals, families, organizations, and states can express and record their income and property in a single form—money.

• Both movable property (gold, silver) and immovable property (houses, land) can be stored in the form of liquid assets (money).

(b) Basis of Credit Creation or Loan

• Banks and financial institutions provide loans based on deposits.

• Money enables credit transactions, and financial instruments like checks and promissory notes facilitate borrowing and lending.

• The invention of money has boosted credit creation and loan facilities.

(c) Distribution of National Income

• Money helps in distributing gross national income among the factors of production:

  • Rent for land

  • Wages for labor

  • Interest for capital

  • Profit for businesses

• All these payments are expressed in money, ensuring a systematic and fair distribution.

(d) Measurement of Marginal Utility and Productivity

• Money helps consumers maximize their total utility by rationally spending their limited resources.

• Producers use money to spend their budget on production factors until their marginal productivity equals the factor price.

• This process helps them achieve maximum production and profit.

Conclusion

As it facilitates effective trade, value storage, and financial activities, money is essential to the economy. Its primary functions help in exchange and valuation, its secondary functions support wealth storage and credit transactions, and its contingent functions contribute to income distribution and productivity measurement.

The development of money has simplified economic activities, replacing the inefficient barter system and ensuring a smooth flow of goods, services, and financial resources.