CLASS 12 'BARTER SYSTEM' ECONOMICS NOTES
BA
CHAPTER 9: MONEY
BARTER SYSTEM:
Concept:
When goods are exchanged for goods between buyers
and sellers then such transaction in market is known as Barter System. In
Barter System people produce goods and services either to consume by themselves
or to exchange surplus products to other products which are necessary for them.
In Barter System goods and services have only real value but no money value.
Eg. Exchange of Rice for Honey.
Difficulties of
Barter System:
1. Lack of
Double Coincidence of Wants: For exchange of goods
and services, two parties having mutual wants and common values of their goods
and services are needed. It made barter a difficult system.
2.Lack of Common
Measure of Value: In barter system the value of goods and
services are expressed in terms of other goods and services. It means there is
no common measure of value.
3.Problem of
Divisibility of Goods: In barter system goods are
exchanged for goods. It becomes very difficult to fix the exchange rate between
two goods which are not divisible.
4.Lack of Store
of Value: Lack of store of value is another problem of barter
system. Since value cannot be stored people produce goods and services to
fulfill their current needs.
5. Difficulty in
making Deferred Payments: Deferred payment refers to
purchase of goods and services in credit which is quite impossible in barter
system due to non-uniformity in quality of goods and services, exchange in
value of goods and services between purchased and repayment periods and lack of
common commodity to be used for repayment.
6.Lack of
Transfer of Value: In barter system value of goods is non
transferable because of transportation system
7.Accounting
Problem: In barter system it is very difficult to keep the
record of goods.
MONEY:
Money may be defined as a commodity unit which is
accepted in payment of debt and which performs medium of transaction between
buyers and sellers in the market.
According to G.R. Crowther in his famous book ‘An
Outline of Money’, ‘Money is a claim of commodity unit which is circulated as
medium of exchange and which is accepted in debt obligations’
According to Robertson ‘Anything which is widely
accepted in payment for goods or in discharge of other kinds of obligations may
be defined as Money’
According to Hartley Withers ‘Money is what money
does’
On the basis of different definitions and approaches
we can therefore conclude that Money may be defined as a commodity unit which
performs function of medium of exchange, measurement of value, standard of
deferred payment and store of value. If these elements are found in a commodity
unit then such an element of commodity unit is known as Money.
FUNCTIONS OF
MONEY:
A. Primary
Functions: There are two major primary functions of
money and they are:
1.Medium of
Exchange: Money serves basis of medium of exchange. In fact,
money solves problem of double coincidence of wants of barter system. The
marketing management of exchange of commodity is facilitated by help of money.
Thus, Money is basic pillar of medium of exchange.
2.Measurement of
Value:The value of a commodity is determined by money. The
monetary unit of a commodity is guided, determined and evaluated by money.
B.Secondary
Functions: There are two secondary functions and they are:
1.Standard of
Deferred Payment:The deferred payment in debt obligation
(loan management) is calculated, guided and regulated by money. If deferred
payment is made after sometime then it is widely and unanimously accepted by
help of money. Thus, problem of deferred payment is normally solved by help of
money.
2.Store of
Value:The monetary value of a commodity is stored in best
possible manner by help of money. If a person or consumer stores his/her wealth
or savings in the form of commodities then it may lose its value in long period
of time. However, if same consumer stores his/her wealth in form of money then
value of property can be stored for a long time practically. Thus, value of
wealth or property is preserved in an effective manner by help of money.
C.Contingent
Functions:These functions are listed as follows:
1.Basis of
Distribution of National Income:GDP and other
components of National Income can be calculated, evaluated and accounted in
best possible manner by the help of money. Thus, money plays vital role in
National Accounting.
2.Money makes
Capital Mobile:An Investor or producer can easily shift
capital for different purposes from one place to another in best possible
manner by the help of money. Thus, capital becomes mobile through monetary
management.
3.Money makes
Capital Liquid:Money converts property or wealth of a
portfolio holder into liquid asset. The cash management is compared with liquid
asset which is supplemented only by the help of money.
4.Money helps to
maximize satisfaction of a consumer:According to Alfred
Marshall the satisfaction of a consumer is measured and calculated by help of
Marginal Utility and MU itself is measured by help of money. The constant MU of
money helps to evaluate total satisfaction of consumer.
5.Money is a
basis of Credit:The bank or money lenders provide loan
to debtor in the form of money. Thus, money serves basis of credit in loan
management.
FORMS OR TYPES
OF MONEY:
1.Commodity
Money:In the beginning various commodities were used as
medium of exchange like bones, leather, food grains etc. However, as commodity
money lacked basic features of good money like general acceptability, stability
etc. therefore people discarded commodity money.
2.Metallic
Money:It is made of metals. There were periods of
mono-metalism and bi-metalism. There are two types of metallic money and they
are:
a.Standard or
Full Bodied Coins: This type of metallic money is made
from valuable metals like gold, silver etc. Face value of standard coins is
equal to its intrinsic value. Its value does not decrease if melted.
b.Token or
Subsidiary Coins: This type of metallic money is made
from inferior metals like copper, aluminium etc. Face value of token coins is
more than the intrinsic value. Its face value disappears if melted and
therefore it is called subsidiary money.
3.Paper Money:It
is made of paper. China was the first country to use paper money in the world
in 17th century. Government or Central Bank of a country issues
paper money. Face value of paper money is more than its intrinsic value. It has
unlimited legal tender. There are four types of paper money and they are:
a.Representative
Paper Money:100% reserve of gold or silver is kept
in order to issue representative paper money. This type of paper money can be
converted into gold or silver because it is fully backed by gold or silver.
b.Convertible
Paper Money:This type of paper money is convertible
into standard coins at any time at the choice of holder. However, there may not
be 100% backing of gold or silver.
c.Inconvertible
Paper Money:The paper money which cannot be converted
into standard coins as the holder wants is called Inconvertible Paper Money.
d.Fiat Money:It
is a type of inconvertible paper money. Fiat Money is issued without any
backing of gold or silver or other securities. Such type of paper notes are
issued in some critical situations as post war situation.
4.Bank
Money/Credit Money:The cheque drawn on demand deposit or
current account is called Bank Money. Other mediums of exchange as Bank Draft,
Traveler’s Cheque, Credit Card etc. are also included in Bank Money. Bank Money
is also called Optional Money as no one can be forced to accept this type of
money.
ROLE OR
IMPORTANCE OF MONEY:
Money plays vital role to facilitate market
transaction requirements of consumers and it is main pillar on basis of which Economic
Development is promoted in a country. The all round development of a country
depends on monetary transactions in a monetized economy.
According to Alfred Marshall ‘Money is a pivot
around which Economic Science Clusters’
The significance of money can be examined relating
it with subject matter of Economics and they are:
1. Money in the
field of Consumption: Consumption may be defined as that
part of income spent by people to fulfill requirements. A consumer can maximize
total satisfaction at that point where MU approaches to zero and MU itself is
compared with money. It therefore appears that money helps to protect the
consumption requirement of people in a country.
2.Money in the
field of Production:The transformation of inputs (L, L, K,
T) into output is called Production. The management of input i.e. L, L, K, T
can be accumulated by an entrepreneur by help of money. In fact, money
facilitates production management through different factors of production. In
fact, if money is dropped from system of production management a producer
cannot complete task of production in practical field of production management.
Thus, production management survives due to existence of money.
3.Money in the
field of Exchange:Exchange refers to marketing management
of selling and purchasing goods between buyers and sellers at a particular
time. The price of a commodity is determined by the help of money. Likewise,
consumer pays price of commodity to seller by money as well. Thus, entire
marketing management runs smoothly through transaction of money in the market.
If money is taken out from system of marketing management then no market
survives either in developing or developed countries.
4.Money in the
field of Distribution:Distribution refers to process of
distributing money value of a commodity among different factors of production
in the form of rent, wage, interest and profit. Likewise, National Income of a
country can be distributed among different sectors as agriculture, industry,
service by the help of money. Therefore, National Income accounting alongwith
budgetary management of a country can be determined by the help of money.
5.Money and
Public Finance:Public Finance deals with income and
expenditure of government. Tax is the prime source of income for government.
What % of income of consumer should be collected as tax, such a productive idea
is injected only by the help of money. Thus, scientific fiscal management can
be maintained in a country by help of money. Likewise, the expenditure of
government is also carried out only by the help of money either in developing
or developed countries of world.
6.Money and
Economic Development:Economic development refers to long term
qualitative process which requires to increase GNP per capita alongwith
development of different sectors of a country. In fact, GNP per capita itself
is calculated by help of money. Thus, quality of economic development is also
guided, promoted, regulated and maintained by help of money.
FEATURES/CHARACTERSITICS
OF MONEY:
Good Money posses following characteristics:
1.
Cognizability i.e. recognizable quickly
2.
Universal Acceptability
3.
Portability
4.
Durability
5.
Indestructibility
6.
Stability of value
7.
Homogeneity
8.
Meltability
9.
Utility
VALUE OF MONEY:
Value of Money is the purchasing capacity of money
relating to prices of goods and services. Purchasing power of money is the
amount of goods and services that a unit of money can buy. The value of money
does not remain same forever, rather it rises or falls. Value of money is
inversely related with general price level. It can be denoted as:
VM =
1/P
Where, VM = Value of Money, P = General
Price Level, 1/P = Reciprocal of general price level
When price level goes up then purchasing power of
money goes down i.e. value of money goes down if price increases.
INFLATION:
An increase in price level is referred as Inflation
in ordinary sense. In Economics Inflation is defined as an event of monetary
phenomenon and event of full employment.
According to G.R. Crowther ‘Inflation is a state in
which value of money is falling i.e. prices are rising’
According to Hawtrey ‘Inflation is issue of too much
currency’
According to Coulborn ‘Inflation is too much money
chasing too few goods’
According to J. M. Keynes ‘An increase in price
level due to expansion of money supply after point of full employment is Real
Inflation’
G. R. Crowther, Hawtrey and Coulborn described
Inflation as a monetary phenomenon but J. M. Keynes defined Inflation as a
phenomenon of full employment.
TYPES OF
INFLATION:
1. On the basis
of Speed:
a. Creeping
Inflation: When general price level increases at
the rate of 2% per annum then such a situation is known as Creeping Inflation.
It is a very good friend of economic development. The government attempts to
create the situation of Creeping Inflation intentionally.
b.Walking
Inflation:When general price level increases by more than 2%
and upto 5% per annum then such a situation is known as Walking Inflation. It
is also considered as a good friend of economic development. Walking Inflation
supports economic development and income employment generation in a country.
c.Running
Inflation:When government fails to control Walking Inflation
then it is converted into Running Inflation. When general price level increases
by more than 5% and touches double digit then it is known as Running Inflation.
It is dangerous for economic development. It reduces purchasing power of
consumers and damages income employment generation in an economy. If Running
Inflation is not controlled in time then it clearly obstructs quality of
economic development and damages living standard of common people.
d.Galloping
Inflation/Hyper Inflation:When general price level increases
by more than 16% and if there is no upper limit of price rise then such a
situation is known as Galloping Inflation. It is also known as Hyper Inflation
and it clearly ruins the foundation of economic development and reduces
purchasing power and living standard of common people to bottom level.
2. On the basis
of Coverage:
a. Comprehensive
Inflation: When price of all commodities increases
at a time in an economy then it is known as Comprehensive Inflation. In other
words when prices of all A to Z commodities increases at a time in an economy
then it is known as Comprehensive Inflation. It is very dangerous for economic
development and it is very difficult to control practically.
b.Sporadic
Inflation/Sectoral Inflation:When price of product
of a particular sector increases but prices of products of other sector remain
same in an economy then it is known as Sporadic Inflation. It is a universal
event commonly observed in all the countries of the world. If government
attempts to control Sporadic Inflation, it can be controlled easily and
effectively.
3.On the basis
of Nature:
a. Open
Inflation: When general price level continues to
increase and if government is unable to control it or government does not want
to control it then is known as Open Inflation. In case of Open Inflation
government becomes helpless in controlling the price level. It is very
dangerous for economic development of a country.
b.Repressed
Inflation/Suppressed Inflation:When government
artificially presses price level to obtain some undue advantage from common
people then it is known as Repressed Inflation. Repressed Inflation is observed
in illiterate societies.
4.On the basis
of Theory:
a. Cost Push
Inflation: When general price level increases with
an increase in cost of production then it is known as Cost Push Inflation. In
this case the price level is pushed by rising cost of production. The major
causes of this inflation can be listed as follows:
1.An increase in
wage rate.
2.An increases
in price of raw materials.
3.An increase in
profit margin of sellers.
4.Imposition of
heavy tax by government.
5.International
reasons as increase in price of crude oil.
6.High level of
mismanagement and inefficiency in production management.
7.Unfavourable
Monetary and Fiscal Policy.
8.Miscellaneous
Factors.
All these
reasons are collectively responsible to create the situation of Cost Push
Inflation.
b. Demand Pull
Inflation: When general price level increases due
to an increase in excess of aggregate demand (AD) over limited
aggregate supply (AS) in an economy then such a situation is known
as Demand Pull Inflation. In fact, price level is pulled out in an upward
direction due to excess of increase in aggregate demand over limited aggregate
supply in case of Demand Pull Inflation. An increase in money supply is the
fundamental cause of Demand Pull Inflation.
The case of Demand Pull Inflation is basically
observed in emerging and development friendly countries of the world. The prime
causes of Demand Pull Inflation can be represented as follows:
1. An increase
in Money Supply.
2. Massive
increase in Public Expenditure.
3. Huge increase
in Private Expenditure.
4. An increase
in Development Expenditure.
5. Deficit
Financing.
6. Inflow of
Money from foreign countries.
7. Unfavourable
Monetary and Fiscal Policy.
8. Miscellaneous
Reasons.
CAUSES OF
INFLATION:
A. Factors causing
increase in Cost of Production:
1. An increase
in Wage Rate: The modern labour union compels employer
to increase the wage rate in production management. An increase in wage rate
increases cost of production and prices of commodities thereby creating the
situation of Inflation.
2.An increase in
Price of Raw Materials:In modern economy the price of raw
materials consistently increase day by day and year after year in both
developed and developing countries. An increase in price of raw materials
increases cost of production which causes to create the situation of
Inflationary Price Rise.
3.An increase in
Profit Margin:Modern producers attempt to maintain as
much profit margin s they can in prices of commodities. Due to significant
profit margin, the general price level increases.
4.Imposition of
Heavy Tax by Government:The modern government imposes high
rate of tax in prices of commodities. Due to imposition of high tax, the
general price level increases in an economy.
5.International
Reasons: Sometimes international business environment also
increases cost of production. As it happens the general price level increases
rapidly in an economy.
6.High level of
mismanagement:In developing countries high level of
mismanagement is observed which increases the cost of production in an unwanted
manner.
7.Unfavourable
Monetary and Fiscal Policy:Sometimes central bank formulates
monetary policy according to the situation of financial market which may be
unfavourable for producer. Likewise, government develops unfavourable fiscal
policy in which high rate of tax is imposed. All these components increase
price level.
B.Factors
Causing Increase in Aggregate Demand:
1. An Increase
in Money Supply: As central bank issues additional money
then too much money chases too few goods. Consequently an increase in money
supply increases aggregate demand situation in society which eventually
increases price level and creates situation of Inflation.
2.Massive
Increase in Public Expenditure:Modern government
attempts to spend public expenditure in different sectors at a massive scale.
The massive increase in public expenditure causes to increase aggregate demand
in society. It also contributes to inflationary price rise in an economy.
3.Huge increase
in Private Expenditure:In the era of liberal market
economy the private sector is equally involved in developmental activities in
country. Due to huge private expenditure the aggregate demand situation in
market increases which causes situation of Inflation in an economy.
4.An increase in
Development Expenditure:Government makes huge expenditure
on different components of development. Due to development expenditure the
aggregate demand of society increases. Such a situation creates inflationary
price rise in an economy.
5.Deficit
Financing:When source of government revenue is not sufficient
to fulfill expenditure requirement then government instructs central bank to
print new notes. It creates pressure in the market which increases general
price level.
6.
Unfavourable Monetary and Fiscal Policy as high rate of interest on loan and
high rate of tax on commodities increases cost of production in an unwanted
manner thereby causing Inflation.
CONSEQUENCES OF
INFLATION:
1. Decrease in
Value of Money:Inflation causes increase in price of
goods and services and decrease in value of money. It results into higher
expenditure and reduces the savings of people.
2.Encourages
Hoarding of Goods:During the period of Inflation,
consumers start to hoard goods due to the fear of further increase in inflation
rate. It creates scarcity of goods in the market.
3.Decrease in
Faith on Domestic Currency: The value of domestic currency
falls continuously due to inflation. Due to this people lose faith on domestic
currency and they may buy foreign currencies.
4.Effect on Output
and Employment:Low rate of inflation stimulates output
and employment but very high rate of inflation reduces output and increases
unemployment.
5.Effect on
Economic Growth:Inflation reduces savings and capital
formation. As capital formation declines, it reduces investment and economic
growth in the nation.
6.Harmful for
Fixed Income Group:As income is fixed and prices rise due
to inflation, it adversely affects fixed income groups.
7.Change in
Structure of Production:Uncontrolled inflation changes the
structure of production from necessary goods to luxurious goods in order to
earn high amount of profit. It creates scarcity of necessary goods in the
market.
8.Decrease in
Inflow of Foreign Capital: High rate of inflation reduces
domestic savings and capital formation and thus inflow of foreign capital
decreases because of fall in profit.
DEFLATION:
The decline in price level is referred as Deflation
in ordinary sense. Deflation refers to a situation characterized by massive
decrease in production, sharp reduction in prices, massive increase in
unemployment, high rate of business failure and above all business and economic
development is absolutely obstructed.
According to G.R. Crowther ‘Deflation is defined as
state in which value of money is rising i.e. prices are falling’
Deflation really damages quality of business and
economic development of a country. The practical application of Deflation is
referred as Depression which is always harmful for production management,
business and marketing management of a country. If Deflation is not controlled
in time it clearly damages the socio-economic and business development of a
country. It is better to take preventive measure against Deflation before its
occurrence rather than curative measure after its occurrence. It is believed
that both Inflation and Deflation damages but Deflation is the worst.
FISHER’S
QUANTITY THEORY OF MONEY:
The concept of transaction approach of quantity
theory of money was first of all developed by famous classical economist Irving
Fisher in his famous book ‘The Purchasing Power of Money’ published in 1911
A.D. The famous transaction approach of quantity theory of money was developed
by Irving Fisher in the form of transaction equation which can be summed up as
follows:
MV = PT
Where, M = Quantity of money in circulation, V =
Velocity of Circulation of Money, P = Price level and T = Total volume of goods
and services transacted (sold and purchased) in an economy.
Fisher assumed that V and T always remain constant.
On the basis of such an assumption, classical economist concluded that there
exists direct and proportionate relationship between quantity of money and
price level. It implies that if quantity of money increases then price level
also increases but value of money decreases. Thus, Fisher concluded that
quantity of money and value of money are inversely related.
Later on Irving Fisher modified transaction equation
in which quantity of bank money and velocity of bank money were also
introduced. Now, modified transaction equation of quantity theory of money can
be represented as follows:
The above equation shows that if quantity of money
and quantity of bank money increase by a certain proportion then general price
level also increases by same proportion and vice versa.
The Fisher’s quantity theory of money can also be
represented by following diagram:
The diagram A clearly shows that as quantity of
money increases from OM1 to OM2 then general price level
also increases from OP1 to OP2 and vice versa. It
justifies that quantity of money and price level is positively and
proportionately related with each other.
The diagram B shows inverse and proportionate
relationship between quantity of money (M) and value of money (1/P). In diagram
B as quantity of money increases from OM1 to OM2, value
of money declines from O/P1 to O/P2.
Assumptions:
1. Money performs only medium of exchange.
2. V and T, V and T always remain constant.
3. Price is a passive element. It implies that Price
cannot affect any variable but is affected by all the other variables.
4. The economy is fully monetized economy.
5. Assumption of Full Employment.
6. Assumption of Long Run.
Criticisms:
1. Narrow
Function of Money: According to quantity theory of money
developed by Irving Fisher money only performs basic function of medium of
exchange. However, critics pointed that money performs many other functions
like measurement of value, store of value, standard of deferred payment and
others. Thus, comprehensive functions of money have not been properly analysed
by Irving Fisher in quantity theory of money.
2. Misleading
Assumption of V, V and T:Fisher assumed that V, V and T
always remain constant in an economy. But modern economists criticized the
approach of Fisher. They argued that V, V and T can remain constant only in
static economy. But due to complexities of modern economic development velocity
of circulation of money cannot remain constant. Due to rapid pace of
development, transaction of money increases which causes V, V and T to increase
as well. Thus, assumption of constant V, V and T seems to be falsified in
Fisher’s Transaction version of quantity theory of money.
3.Price is not a
Passive Element:According to Fisher’s Transaction
approach of quantity theory of money Price is a passive element because Price cannot
affect any of economic variables. However, Price is affected by quantity of
money and other economic variables. But modern economists argued that a change
in price level can affect purchasing power of people. It also affects profit
margin, Investment of capital, Income employment generation and other economic
variables as well. Thus, Price is not a passive element in practical field of
transaction.
4.Wrong
Assumption of Full Employment: Fisher’s Transaction
Equation explains MV = PT, where MV shows money supply whereas PT refers demand
for money. The equality between MV and PT shows that entire supply of money is
demanded in an economy. But in practical field of development the equality
condition of MV and PT is not satisfied. Thus, it helps to conclude that
Fisher’s Quantity theory of money is based on falsified assumption of full
employment.
5.Existence of
Barter System:The quantity theory of money by Irving
Fisher is based on assumption that country is fully monetized and barter system
does not exist. But observation shows that barter system is still practically
exercised in poor and backward countries of the world. Thus, quantity theory of
money becomes helpless for developing countries where barter system still
exists practically.
Comments
Post a Comment