Basic Concepts of Money
Evolution of Money and Barter System’s Limitations:
- Before money, the barter system dominated, where goods were directly exchanged for other goods. This faced challenges like:
- Double coincidence of wants: Both parties needing what the other offers, making transactions difficult.
- Indivisibility of goods: Difficult to divide certain goods (e.g., a cow) for smaller transactions.
- Lack of a common measure of value: Comparing the value of different goods was complex.
Functions and Types of Money:
- To overcome these limitations, money emerged as a:
- Medium of exchange: Accepted by all for goods and services, eliminating double coincidence.
- Unit of account: Measures the value of goods and services in a common unit (e.g., rupees).
- Store of value: Ideally, retains purchasing power over time.
- Two main types of money exist:
- Commodity money: Has intrinsic value, like gold or silver.
- Fiat money: Value comes from government backing and general acceptance (e.g., paper currency).
- Modern forms include:
- Paper currency: Convenient and widely accepted, but lacks intrinsic value.
- Coins: Similar to paper currency, but often made of more durable materials.
- Digital money: Electronic representation of money stored and transferred electronically (e.g., bank accounts, debit/credit cards).
Role of Credit and Banking System:
- Credit allows borrowing money for various purposes, like investment or consumption.
- Banks play a crucial role as intermediaries:
- Accepting deposits from individuals/businesses with surplus funds.
- Providing loans to individuals/businesses needing funds, charging interest.
- This creates a flow of money: savings are transformed into investments, stimulating economic activity.
- Different types of credit exist, each with specific terms and conditions:
- Formal credit: Obtained from banks or financial institutions under regulated terms.
- Informal credit: Borrowed from moneylenders, friends, or family, often with higher interest rates and fewer regulations.
Impact of Money and Credit on the Economy:
- Money and credit contribute to economic growth and development by:
- Enabling specialization and division of labor: Individuals focus on specific tasks, increasing efficiency.
- Facilitating trade and investment: Money promotes exchange of goods and services, and credit allows for larger investments.
- However, misuse of credit can lead to negative consequences:
- Inflation: Excessive money supply can decrease the value of each unit, impacting purchasing power.
- Financial instability: Unrepaid loans can strain financial institutions and destabilize the economy.
Additional Points:
- Additional read evolution of banking from traditional moneychangers to modern institutions offering various financial services.
- Importance of credit management responsible credit management for individuals and businesses.
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