NCERT Book Class 12 Economics (Macroeconomics) Chapter 3 Money and Banking

Money and Banking

Money is the commonly accepted medium of exchange. In an
economy which consists of only one individual there cannot be
any exchange of commodities and hence there is no role for money.
Even if there is more than one individual but these individuals do
not take part in market transactions, example: family living on an
isolated island, money has no function for them. However, as soon
as there is more than one economic agent who engage themselves
in transactions through the market, money becomes an important
instrument for facilitating these exchanges. Economic exchanges
without the mediation of money are referred to as barter
exchanges. However, they presume the rather improbable double
coincidence of wants. Consider, for example, an individual who
has a surplus of rice which she wishes to exchange for clothing. If
she is not lucky enough she may not be able to find another person
who has the diametrically opposite demand for rice with a surplus
of clothing to offer in exchange. The search costs may become
prohibitive as the number of individuals increases. Thus, to
smoothen the transaction, an intermediate good is necessary which
36 is acceptable to both parties. Such a good is called money. The
individuals can then sell their produces for money and use this
Introductory Macroeconomics

money to purchase the commodities they need. Though facilitation
of exchanges is considered to be the principal role of money, it
serves other purposes as well. Following are the main functions of
money in a modern economy.

3.1 FUNCTIONS OF MONEY
As explained above, the first and foremost role of money is that it
acts as a medium of exchange. Barter exchanges become extremely
difficult in a large economy because of the high costs people would
have to incur looking for suitable persons to exchange their
surpluses.
Money also acts as a convenient unit of account. The value of
all goods and services can be expressed in monetary units. When
we say that the value of a certain wristwatch is Rs 500 we mean
that the wristwatch can be exchanged for 500 units of money,
where a unit of money is rupee in this case. If the price of a pencil
is Rs 2 and that of a pen is Rs 10 we can calculate the relative
price of a pen with respect to a pencil, viz. a pen is worth 10 ÷ 2 =
5 pencils. The same notion can be used to calculate the value of