Money is defined as anything that is generally accepted as a medium of exchange (i.e. means of transferring ownership of goods and services from one person to the other)
Origin of Money
Money has a long history; various items have been used as money at different period and in different places, e.g. shells, animals, elephant tusks, human slaves, tobacco, metals, silver and gold. These items has three (3) major characteristic, one its value as commodity is as great as it value as money. Secondly, their production involves some real cost to their society e.g. to produce gold requires the discovering and exploitation of gold reserves, the use of elephant tusks requires the hunting of elephant etc.
Thirdly commodity monies are hardly able to remain in circulation in their pure forms.
Transactions were carried out by trade by barter. Trade by barter means that a man that has goats but want rice must look for a man who has rice and wants goat for exchange to take place.
Importance or Functions of Money
Money has four (4) main functions,
- It serves as a medium of exchange
- It serves as a unit of account
- It serves as a standard of deferred payment
- It serves as a store of value.
Medium of exchange
Before the introduction of money, trade was carried out by barter for example a farmer who has yam and desires to have shoes must search out another individual who not only produces shoes but also desires to have yam before an exchange can take place.
Money as a unit of account
Money as a unit of account provides a yardstick by which the value of goods and services can be measured. The price of a commodity (in terms of the monetary unit that must be paid for it) reflects the value attached to the commodity also the rate of inflation; profit and losses etc are all expressed in terms of money.
Money as a standard of deferred payment
The use of money enables goods and services to be sold for payments at a future date (i.e. facilities credit transaction). Transactions are done in this way e.g. labor services are sold in anticipation of payments at the end of a period (a day or month).
Money as a store of value
Money is the most common way of holding wealth, specifically money is an indirect way of storing up goods and services since it can be used to purchase any desirable goods or services at any time.
Characteristics/Qualities of Good Money
For money to fulfill effectively the above functions, it must possess the following qualities
- Acceptability: It must be generally acceptable, only something generally acceptable can fulfill the functions of a medium of exchange, standard of deferred payment, a unit of account and a store of value
- Scarcity: Good money must be scarce. In case of fiat money the legal right to production must rest only in the government through its central bank
- Durability: A commodity that can easily lose its physical form or intrinsic value cannot serve as money; hence good money must be durable.
- Divisibility: It must be possible to divide good money into different denominations. The Nigerian Naira (₦) for example can be divided into 50 kobo, N1, N5, N10, N20, N500 etc
- Portability: Money must be portable i.e. it can easily be carried from one place to another. The use of paper currencies has greatly eased the portability of money.
Types of Money
Commodity money (2) fiat money (3) bank money
This is the earliest type of money; it could be any commodity, in some societies, items like cowry, shell, metals, gold, silver, copper have all serve as money.
Commodity money has 3 notable characteristics
- It value as commodity is as great as its value as money
- Their production involves some real costs to the society
- They are hardly able to remain in their circulation in their pure forms
Fiat money is fiduciary issues by the monetary authorities of a country, such issues are generally legal tenders. A legal tender is any commodity that is declared by law to be money, they usually take the forms of national currencies (paper and coins) generally the value or cost as a commodity is less than its value as money. Their value in use as money is derived from the confidence and trust the public express in them as mediums of exchange.
Bank money is money on deposit in banking institutions, such money can be withdrawn with or without notice by the owner of the account by issuing a cheque drawn on the bank concerned. Bank money is very important in a modern (monetary) economy, since it will be cumbersome if all transactions have to be effected by means of legal tender
How Banks Create Money
The banking system in general and commercial banks in particular can help to expand the stock of money in circulation in an economy, (remember that stock of money is the quantity of high powered money in circulation plus demand deposits with banks). In other words commercial banks create money.
To start with, we make some assumptions as follows:
- There are many banks in the system
- The economy is closed (no foreign sector or transaction)
- There are fixed legal amount each reserve that must be kept by banks, loans are also given
Assuming that an individual deposits an amount (N 5million) in a bank (A). the bank on receiving the money will keep twenty five percent (N1.25million) and loan out the remaining N 3.75 million to another deficit unit, the second deficit unit deposits the money in another bank (B) bank B keeps 25% (N0.9375million) and loan out N2.8125 million, the third deficit unit on receiving this amount deposits the same in a third bank (C). C keeps N0.7031million and loan out N2.1094million… and the process continues until the original cash receipts of N5 million has been diffused into the whole banking system in the form of cash reserves. In other words at the end of the money creation exercise the total amount of cash reserves in the banking system would be equal to the initial deposit of N5m. the deposit will be N20 million, while the total loan granted will be N15 million, hence the banking system would have created an additional N15 million out of the original N5 million deposited.
Factors Influencing the Demand and Supply of Money
In any free market system, demand and supply are influenced by the price system or mechanism. Demand here, means effective demand in which the quantity of that commodity that people are willing and able to buy at any given price. It has been established in economy that there is a negative or increase relationship between quantity demand and supply.
The only factor influencing demand and supply is price. The law of demand says that the higher the price the lower the quantity demanded and the lower the price the higher the quantity demanded all other factors remaining constant.
Note: demand for money means the amount of wealth everyone in the economy wishes to hold in form of money balances.