1.0. INTRODUCTION
Money is a difficult concept to define, partly because it fulfills
not just one but various
functions, each of them providing a criterion of moneyless. There
has been lots of controversy
and debate over the right definition of money, because people have
defined it base on the
functions it performs in an economy. In this note, you shall learn
about what money is, and its
function in the economy.
2.0. OBJECTIVES
At the end of this note, you should be able to;
· Define money
· List and explain the attributes of money
· Define and explain the concept of demand for
money
· Define and explain the concept of supply of
money
· Identify and explain the determinants of demand
for money and the determinants
of supply of money
3.0. MONEY
7.1. What is Money?
Money has been defined by many people in different way base on the
functions
which money perform in an economy. So of the definition of money
given by
different scholars include the ones below.
i. Money may be defined in a functional sense as anything
generally used in the
purchase of goods and services and in the discharge of debts.
ii. Money can be regarded as anything that is commonly accepted as
a medium of
exchange and as an instrument for the final settlement of a debt.
iii. Money is any commodity that is generally accepted in a
locality as a means of
payments for goods and services and in settlement of debt.
The above definitions are all functional definitions of money
because they define money
in terms of the function it performs. One common feature in the
definition of money is its general
acceptability by a particular society as a means of payment for
goods and services and settlement
of debts.
3.2. Attributes of Money
General acceptability: This means that the commodity used as money must
be generally
accepted by people of a locality. If money possesses other qualities
without being generally
acceptable, it cannot function as a medium of exchange. The
acceptability is the most
essential feature of money.
Portability: The commodity to serve as money should be such
that it could be carried along
with ease or transferred from place to place without difficulty.
Divisibility: It must be capable of being divided into small notes
or denominations to allow
for exchange of small quantity of goods.
Durability: The commodity should be capable of being kept
for a long time without
deteriorating easily, else, it may not be a good store of value.
Stability: Stability in the value of money is also
essential if money is to perform its functions
satisfactorily. It is important that since money performs the
function of a store of value or a
standard of deferred payments, its value must not fluctuate
excessively.
Homogenous: This implies that the commodity must be
identical in all respects to allow
smooth exchange transactions take place. For example, a five naira
note in Lagos should be
an exact replica of another five naira in Jos.
Scarcity: For money to have value and therefore be
acceptable, it must be relatively limited
in supply relative to demand and the productive capacity of the
country. In other words, to be
generally acceptable, the supply of anything being used as money
must be restricted. It must
neither be too plentiful, nor too scarce.
Recognizability: For anything to serve as money, it has to be
easily recognized. If it is not
easily recognized, market participants will find it difficult to
determine whether they are
dealing with money or some inferior assets like a counterfeit.
It must be a legal tender: The commodity must be backed by law so that
debtors could
compel their creditors to accept the commodity as a means of payment
and in settlement of
debt.
3.3. Functions of Money
Money performs the following functions in an economy.
Medium of exchange: This is one of the primary functions of money.
It is said to be a
primary function in the sense that out of this function, other
functions are derived. To
say that money serves as a medium of exchange means that market
participants
(buyers and sellers) will accept it as payment. That means that it
is generally
acceptable and therefore, affords the freedom of choice. As a
medium of exchange,
individuals can sell their output for money and use that money to
make purchases in
the future. In this process, money facilitates exchange through
specialization and
division of labor. Money, as servicing as a medium of exchange
also eliminates the
inconveniences and difficulties of barter, especially the need for
double coincidence
of wants.
Money as a store of value: As a store of value, money enable us preserve
wealth in a more durable form, without having to keep bulky
inventories. To do this, money material should be durable and
value of money itself
be relatively stable. But we know that value of money depends on
price so that money
cannot perform this function of store of value well in a period of
inflation. However,
it is because money can store value that we can defer payment.
Money as a note of account: Money as note of account serves as a note
In terms of which the value of all goods and services are measured
and
expressed. That is, as a note of account, money is used to express
prices or values in
exchange of commodities. For instance, in Nigeria, the exchange
price of goods and
services is expressed in naira and kobo. The use of money in this
manner promotes
orderly pricing system for rational choice in production and
consumption.
Put in another way, money serves as a note in terms of which
values of goods and
services are measured and expressed. It is a note in which people
express debt, values
of goods and in which wealth is measured and compared. In other
words, money is a
common denominator which determines the rate of exchange between
goods and
services which applies in terms of monetary notes.
Money as a standard for deferred
payment: Money as a standard for
deferred payment has made it possible for us to buy something
today and pay
tomorrow. You know that a lot of transactions and contracts take
place on the
understanding that the payments will be done in the future. This
is possible because
money not only serves as medium of exchange but also as a note of
value hence future
payments are stated in monetary note provided its value of
purchasing power is stable
overtime.
3.4. Demand for Money
3.4.1. What is Demand for Money?
Demand for money refers to the total amount of money balances that
people want to hold for
certain purposes. This refers to the desire to hold money in its
liquid from (i.e. cash) instead of
investing it in a business. According, to Lord John Maynard Keynes
there are three reasons for
holding money in cash form, Transaction, and Precautionary and
Speculative motives for holding
money.
3.4.2. Motives for holding Money
3.4.2.1. The Transaction motive:
This refers to the desire to hold cash for day-to-day buying and
selling of goods and services.
This quantity of money to be held depends on an individuals’
income and the interval between
one pay day and the next. Generally, the higher the income, the
greater the amount of money
held for this purpose, all things being equal. Again, the longer
the interval between one pay-day
and the next, the higher the amount of cash held all things being
equal.
3.4.2.2. Precautionary motive
Money is also demanded to cater for emergencies or to provide for
unseen expenditures.
Individuals and businesses also desire to hold cash in order to
take care of emergencies, such as
sicknesses, entertainment of unexpected guests, unplanned repairs
of factory equipments,
accidents, etc. Again, how much is to be held for this purpose
depends largely on one’s income.
Higher income earners are likely to hold more money for
precautionary purpose than the lower
income earners.
3.4.2.3. Speculative motive
This refers to the desire to hold cash to take advantage of
profitable investment opportunities. It
has to do with money held for the purpose of avoiding capital
losses in a decline securities
market. This arises out of uncertainty. Due to changing or
fluctuating interest rates, the
individual may decide to hold money in cash or in bonds in
equities, etc. This varies inversely
with the rate of interest. The strength of the desire for
liquidity is called liquidity-preference. It is
this that helps to decide what proportion of individuals assets
will be held in the form of money.
3.4.3. Determinants of Demand for Money
Factors such as the price level, the rate of change of prices or
inflation, real permanent
income or wealth and return on bonds and equities have been
identified by Keynes and Friedman
as the determinants of money demand in an economy. These are
explained below:
Income: Demand for money varies directly with the level
of income, that is,
the higher the level of income, the higher the level of money
demand.
Interest rate: Demand for money varies inversely with the
interest rate i.e. the higher the
interest rate, the lower the demand for money and the lower the
interest rate, the higher
the demand for money.
Price level: There is direct positive relationship between
money and price
level.
The rate of price changes: Demand for money varies inversely with inflation
rate. This
is said to be a weak determinant of the demand for money.
Real permanent income: Money demand varies directly with permanent
income or
wealth. The higher the return on bonds and equities the lower the
demand for money
3.4.3. Money Supply
This refers to the total quantity of money in circulation at any
point in time. It
comprises currency (i.e. naira and kobo) and demand deposit (Bank
Money). The level of
money supply depends on the monetary and credit policies pursued
by a country at any
given period of time. If a country through its monetary
authorities (i.e. Central Bank)
pursues a contractionary or tight money policy, the level of
supply of money will be
small. But if on the other hand, an expansionary or loose or easy
monetary policy is
pursued, size of supply of money will be large.
3.4.3.1. Determinants of Money Supply
Money supply is generally determined by the Central Bank behavior,
the behavior of
non-bank public, and the behavior of the commercial banks in an
economy. More
specifically, money supply is determined by the following factors.
Total reserves supplied by the
Central Bank: If the total reserves
supplied by the Central
Bank are high, money supply will be high.
Reserve requirement: If the reserve requirement (percentage of
commercial banks’ deposit
legally required to be kept with the central bank) is high, money
supply will be low.
Demand for currency: If the non-bank public increases its demand for
currency, money supply
will increase.
Demand for time Deposits: If the non- bank public increase its demand for
time deposits,
money supply increases.
Demand for excess reserves: If commercial banks demand for excess reserves
increases,
currency supply increases.
Interest Rates: There is a positive relationship between money
supply and interest rates. That is,
the higher the interest rate, the higher the money supply.
The bank rate: If the rate at which commercial banks borrow
from the Central Bank or discount
bills rises, money supply falls.
4.0. CONCLUSION
Money is anything that is generally acceptable in a society for
exchange of goods and services
and for the settlement of debts in that society. It facilitates
economic development of nations.
This note discusses money, its functions and its determinants in
respect of its supply and demand.
5.0. SUMMARY
In this note, we have learned about;
· Money, its attributes and functions
· The demand for money
· The supply of money
· The determinants of the demand and supply of
money.
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