What is money ?

Invention of Money Increasing difficulties and inconveniences of the barter system led to the invention of money. As the society developed, the division of labour and specialisation increased and, as a result, volume of production and trade expanded in such conditions, the barter system of direct exchange between various Commodus Created difficulties. Such as, the problem of double coincidence of wants, the problem of common measure of value, etc. In order to overcome these difficulties, money was invented. Money is , in fact one of the greatest inventions of Man. Since money represents generalized purchasing power , it has been the object of mans desire to accumulate it throughout ages.

 According to Crowther, "Money is one of the most fundamental of all man's inventions. Every branch of knowledge has its fundamental discovery. In mechanics it is the wheel, in science fire, in politics the vote. Similarly, in Economics, in the whole commercial side of man's social existence, money is the essential invention of which all the rest is based". Money was an invention in the sense that "it needed the conscious reasoning power of man to make the step from simple barter to money-accounting".

1. Animal Money: In primitive agricultural communities, domestic animals were used as money. Cattle were considered the common instrument of exchange. Different things were valued in terms of the number of cattle they can command in exchange. In ancient India, according to Arth Veda, Go-Diam ^BSSSeeZZ was accepted as a form of money. Similarly, upto the 4th century B.C., cow and sheep were officially recognised forms of money to be used for collecting fines and taxes in the Roman State. In Homeric poems (written in probably 9th century B.C.) the prices of commodities were expressed in terms of oxide. 2. Commodity Money: In many countries, primitive money took the form of commodity money. A number of commodities like, bows, arrows, animal skins, shells, precious stones, rice, tea, etc., were used as money. The selection of a commodity to serve as money depended upon different factors, like, the location of the community; climate of the region; cultural and economic development of the society etc. For example, communities living by the sea shore chose shells or fish-hooks as money. In the cold ' Siberia, people adopted animal skins and furs as money. In the tropical regions of Africa, elephant tusks and tiger jaws were used as money.

3. Metallic Money: With the growth of society from pastoral to commercial stage, the composition of money also changed from animal and commodity money to metallic money. Gold and silver were the metals mostly used to form metallic money. Due to their scarcity, usefulness and attractiveness, gold and silver were regarded as natural money. The use of metals as money ultimately led to the development of coinage system. According to A.J. Toynbee, the coinage began in Lydia, a Greek City State around 700 B.C. The coinage continued till the 17th century. Metallic money (uncoined metals and coins) overcame most of the diffculities of animal and commodity money. But, it had its own disadvantages: (a) Quick transactions are not possible through coins. (b) On account of its weight, large quantites of coins are not easily portable; (c) Metallic money can be easily lost and stolen. (d) Short-weighing and adulteration problems make the transaction costs of uncoined metallic money higher. Every time the quantity and quality of the metal is to be tested.

Money
Every branch of knowledge has its fundamental discovery. In mechanics, it is the wheel; in science, fire; in politics, the vote. Similarly, in economics, in whole commercial side of mans social existence, money is the essential invention on which all the rest is based. Geoffery Crowther

Definition
Money is what money does- Walker commodity, which is used to denote anything is widely accepted in payment for goods or in discharge of other business obligations. Robertson

Definition
Anything which is generally acceptable as the mean of exchange (as a mean of settling the debts) and that at the same time act as a measure and as a store of value G. Crowther

Money
According to the traditional economist, money includes not only paper notes and metallic coins, but also the demand deposits of commercial banks. According to the Radcliffe committee report(1959), money includes not only currency in circulation, but also all liquid assets (saving bank deposit, short term securities etc.) held by individual.

Money
According to central bank approach, money includes not only currency in circulation but also various types of commercial bank deposits plus all credit created by various banking agencies operating in the economy.

Money and Currency

The term currency includes metallic coins and paper notes. These are legal tender & are in actual circulation in the country The term money includes not only coins & paper notes but credit instruments also. Thus we can say that all currency is money but all currency is not money.( All money is not currency)

FUNCTIONS OF MONEY
Primary or Main functions Secondary functions Contingent functions Other functions

Primary functions
These are also known as original functions Money as a medium of exchangeit has a quality of general acceptance, it plays a mediator role between purchases and sales, it replaced barter system with money exchange system. In The modern exchange system money acts as the intermediary in sales and purchases. It is on this account that the money is referred as the medium of exchange.

Primary functions
Money is a measure of value Money serves as a common measure of value in terms of which the value of all goods and services is measured and expressed. By acting as a common denominator, money has provided a language of economic communication. It has made transactions easy and simplified the problem of measuring and comparing the prices of goods and services in the market. Prices are but values expressed in terms of money.

Money also acts as a unit of account

As a unit of account, it helps in developing an efficient accounting system because the values of a variety of goods and services which are physically measured in different units (e.g, quintals, metres, litres, etc.) can be added up. This makes possible the comparisons of various kinds, both over time and across regions. It provides a basis for keeping accounts, estimating national income, cost of a project, sale proceeds, profit and loss of a firm, etc.

Secondary function
Money is the standard of deferred payment Money is a store of purchasing power Money is a mean of transferring purchasing power

Money is the standard of deferred payment

Due to the in absence of money during barter system borrowing and lending were difficult to perform. But in the modern money economy has greatly facilitated the borrowing and lending process. Now both borrowing as well as lending are done in terms of money. In other words ,money now acts as the standard of deferred payments. Money has proved to be a suitable standard of deferred payments for the following three reasons The value of money is more stable as compared to the values of other commodities . Money is more durable compared to other commodities. Money has the quality of general acceptability.

Money is a store of purchasing power

During barter system ,savings used to be discouraged because savings used to be done in terms of commodities some of which happened to be perishable .thus savings done in terms of commodities were not permanent. But with the invention of money ,savings are now done in terms of money. Capital accumulation Turning out to be necessary for the economic growth and also serves as an excellent store of wealth , as it can be easily converted into other marketable assets such as land ,machinery etc.

Money is a mean of transferring purchasing power

Money also functions as a means of transferring value. Through money, value can be easily and quickly transferred from one place to another because money is acceptable everywhere and to all. For example, it is much easier to transfer one lakh rupees through bank draft from person A in Amritsar to person B in Bombay than remitting the same value in commodity terms, say wheat.

Contingent function
Prof. Kinely money has to perform certain additional in developed countries, known as contingent function of money. Money is the basis of credit Money facilitates distribution of social income Money helps to equalize marginal utility & marginal productivity Money increases productivity of capital

Money is the basis of credit

Credit plays an important role in the modern economic system and money constitutes the basis of credit. Credit instruments are used on extensive scale. The use of cheques ,bills of exchange etc has gone up .it should however be remembered that money is the basis of credit .without money credit instruments can not circulate . People deposit their money (saving) in the banks and on the basis of these deposits, the banks create credit.

Money facilitates distribution of National income

Money facilitates the division of national income between people. Total output of the country is jointly produced by a number of people as workers, land owners, capitalists, and entrepreneurs, and, in turn, will have to be distributed among them. Money helps in the distribution of national product through the system of wage, rent, interest and profit.

Maximization of Satisfaction
Money helps consumers and producers to maximize their benefits. A consumer maximizes his satisfaction by equating the prices of each commodity (expressed in terms of money) with its marginal utility. Similarly, a producer maximizes his profit by equating the marginal productivity of a factor unit to its price.

Money increases productivity of capital

Capital is to be found in several forms, but money is the most liquid type of capital. In other words ,capital in the form of money can be put to any use. It is on account of this liquidity of money that capital can be transferred from the less productive to the more productive uses. The mobility of capital has also increased on account of the liquidity of money.

Classification on the basis of nature of money J M Keynes classified money under the following 2 heads Actual Money Money Of account Actual money - we mean money which is current in practice in a country. Actual money is the medium of exchange as well as the basis of deferred payments. Goods and services are bought and sold in the market with the help of this money .the purchasing power can be stored only in terms of actual money. Money of accounts this refers to that type of money in terms of which the accounts are maintained in the country. The magnitudes of loans, prices and purchasing power etc are all expressed in terms of account. For example Rupee is for India , dollar for America .

Classification on the basis of legality

Legal tender money Optional money Legal Tender Money; It is that money which is accepted as a means of payment both by the Govt as well as the people. This type of money has legal sanction behind it. No one refuse to accept it as a means of payment. Legal tender money can be further subdivided under two heads: a) limited legal tender, b) unlimited legal tender. Limited Legal Tender is that money which no person can be forced to accept beyond a certain maximum limit. The Govt under statute fixes the maximum limit. For example 1,2,5,10,20 and 25 paise coins are legal tender only up to a sum of rupees twenty-five. If some one is called upon to accept the small coins beyond the maximum limit of Rs 25/- is perfectly free to refuse them. But up to the limit of Rs. 25/-, he cannot refuse the small coins under the provisions of the law. Un-Limited Legal Tender is that money which a person has to accept up to any limit, because it is an unlimited legal tender. This type of money accepted by the people to an unlimited extent. For example, one rupee coins, fifty paise coins and paper notes of all denominations are unlimited legal tender in India.

 Optional money: It is that money, which ordinarily accepted by the people, but has no legal sanction behind it. No one can be forced to accept this type of money against his wishes. It is optioned money. If the persons is paying this money enjoys high credit in the market, everyone will readily accept it. But as pointed out above, no one can be forced to accept it. Different types of credit instruments like cheques, hundies and bills of exchange are examples of optional money. Classification on the basis of the commodity used in making it. Metallic money Paper money Metallic Money: This money is made of a particular metal (i.e., Gold, Silver, Copper, Nickel, etc.,). Metallic Money is further classified under three sub heads: Standard Money Token Money Subsidiary Money

Standard Money: This is also referred to as the principle money or full-bodied money. Standard coins are made of gold or silver. These coins are made of a well-defined weight and fineness. Standard money has the following characteristics: Standard coin is the principal coin of the country. The Face value of standard money is equal to its intrinsic value. There is free coinage of standard money. Standard money is unlimited legal tender money.

Token money:
The token money is used for making smaller payments. It serves as a subsidiary for standard money. It is generally made of inferior and light metals, such as, copper, nickel etc,. Subsidiary money: Subsidiary coins are issued to facilitate smaller payments. The main characteristics of subsidiary coins are: The subsidiary coins are low-value coins and are made of lighter metals. They facilitate the exchange of low-priced goods and services There coins are not subject to free coinage, they are issued by the government itself

Paper Money: Paper money has along history to its credit. China was the first in the world to make use of this in the 9th century and it began in India in the 19th century. Paper money can be classified under three heads:
Representative Paper Money Convertible Paper Money In-Convertible Paper Money Fiat Money

Representative Paper Money: This type of paper money is fully backed up by gold and silver reserves. In the beginning to avoid wastage of metals the paper currency was issued. Hence, the monetary authority maintained metallic reserves equivalent to the value of paper notes issued. The demand for converting paper notes into cash was met by making use of gold and silver kept in reserves. Thus, under the system of representative paper money, gold and silver equivalent to the value of paper notes issued were kept in reserves by the monetary authority. Convertible Paper Money: It refers to that type of paper money, which is convertible into standard coins at the option of the holder. Inconvertible paper money; This system prevails in a country when the monetary authority gives no guarantee to convert the paper notes into coin or other valuable metals. Such a type of paper currency circulation account of the high credit enjoyed by the monetary authority. .

 Fiat money this is the only a variety of inconvertible paper money . It is issued generally at the time of crisis. Thats why it is called as emergency currency. No reserves of any type are kept behind fiat money. It is backed up neither by the metallic nor the fiduciary cover. Charecteristics Fiat money is issued at a time of crisis. Issued in limited quantities. There is no cover or backed up by anything.

Importance of money
advantage to the consumer Advantage to the producer Money transforms savings into investment Money facilitates trade Money has made future transactions possible Importance in distribution Money makes efficient accounting and budgeting possible. Money helps to raise living standards

MONETARY STANDARD
The Term monetary standard refers to the type of standard money used in a country. The monetary standard is synonymous with the standard money adopted by a countrys monetary authority. If the standard money happens to be made of gold the country is said to be on the gold standard. If the standard money is of paper , the monetary money is referred to as paper standard.

 A monetary standard is basically national in character since it is intended by the monetary authority to cater to the internal requirements of the country providing as a medium of exchange and a measure of value within the borders of the country. But the monetary standard has also its international aspects. A sound monetary standard has 2 main objectives To maintain stability in currencys internal value or the internal price level. To maintain stability in the currencys external value i.e. its exchange value in terms of foreign currencies

Gold Standard
Great Britain was the 1st country to have adopted the gold standard. Later on other countries of Europe also adopted the gold standard in the beginning of the 20th century. But after the 1st world war ,Great Britain abandoned the Gold standard in 1931.other countries of Europe also followed the same and the Gold standard disappeared from all countries of the world including the USA .

Features of gold standard

Definition of standard money in terms of gold Gold money is unlimited legal tender money Sale and purchase of gold by the monetary authority . Free coinage of gold . Convertibility of other types of money into gold . No restriction on import and export of gold .

Functions of Gold standard

To maintain stability of the internal price level- this is an important function of the gold standard. Additional currency under the gold standard cannot be issued unless additional gold reserves are available. There is a direct relationship between money and gold under this standard. In order to issue additional currency ,the monetary authority needs additional gold reserves. Since gold reserves are not found in unlimited quantities ,there is no danger of any exclusive issue of money under gold standard . The possibility of inflation is almost non existent.

 To maintain stability in foreign exchange rates gold standard renders useful service in maintain exchange stability which in turn , stimulates the foreign trade of the country. Under this monetary system , government sells gold to an unlimited extent at a fixed price. The people can buy gold in the desired quantity at the price. If the balance of payments of the country turns unfavorable ,the importers would like to make foreign payments in gold instead of foreign currencies because the monetary authority is ever ready to sell gold at a fixed price. When importers make foreign payments in gold ,the demand for foreign currencies will naturally go down. Therefore ,there will be no rise in foreign exchange rate.

 Gold standard could be broadly classified into direct gold standard and indirect gold standard. Direct gold standard it referred to as gold coin standard or gold currency standard. Indirect gold standard is mainly of 4 types the gold bullion standard ,the gold exchange standard , the gold reserve standard and the gold parity standard .

Gold currency standard

Features 1. Circulation of gold coins 2. Circulation of paper and other types of money 3. Free coinage 4. Purchase and sale of gold by the government 5. Free import and export of gold 6. Gold is the measure of value

Gold bullion standard

Gold coins do not actually circulate under gold bullion standard. The internal currency consists of token coins and paper notes . Features No circulation of gold coins No free coinage of gold Paper money is not backed up fully by gold Sale and purchase of gold at fixed prices No restrictions on import and export of gold

Gold exchange standard

The Govt takes no responsibility of converting internal currency into gold for meeting domestic requirements . On the contrary ,the government undertakes to convert local currency into the currency of another based on the gold standard for making foreign payments . In this standard , the internal currency has no direct relationship with gold . But the internal currency is linked at a fixed exchange rate with the currency of another country which is itself is convertible into gold . Features Circulation of token money and inconvertible paper currency Indirect link with the gold Gold is available only for making foreign payments Absence of a free gold market

The gold reserve standard

To ensure stability of exchange rates, Great Britain ,USA and france entered into a Tripartite Monetary Agreement in 1936. The monetary system adopted by these countries under this agreement is referred to as Gold Reserve Standard . The main objective of the agreement was to establish exchange stability among these countries . Features No link with gold Restrictions on import and export of gold Establishment of exchange equalization fund

Gold Parity Standard

This standard came into existence with the establishment in 1946 of the IMF. Every member country of the IMF has to define the value of its money in terms of gold. Features local currency has no link with gold Definition of money in terms of gold Every member country follows an indepent monetary policy

Paper Currency standard

Also referred to as Managed currency standard. Under this standard ,there are no standard coins. Paper currency is the main currency of the country. Hence ,it is an unlimited legal tender . For making smaller payments ,coins made of cheaper and lighter metals are used by the public. Paper currency is not convertible into any metal. Under this system ,the controller of currency regulates the value of money by controlling its supply. Under this standard no metallic reserves are kept to back up paper currency .

ADVANTAGES OF THE PAPER CURRENCY STANDARD

The paper currency standard which is universally used, has a number of merits. Some of these are stated below. 1. Economical: The paper currency standard is cheaper than the gold or silver for coinage purpose. Rather precious metals can be used for productive purposed and for making payments for foreign countries. As paper money is not convertible, there is no need to keep gold in the form of reserves. The money authorities keep only a fixed quantity of gold in reserve for reasons of security. Thus paper standard is cheap and economical and even a poor country can easily adopt it. 2. Elastic: The paper standard is a highly useful. Monetary system because it possesses great elasticity. The monetary authority can easily adjust the money supply in accordance with the requirements of the economy. This was not possible under the gold standard. The supply of money can be increased by printing more notes in times of financial emergency, war and for economic development. It can also be reduced when the economic situation so demands. Thus there is also freedom in the management of the money supply in the economy.

 3. Price Stability: The paper standard ensures price stability in the country. The monetary authority can stabilise the price level by maintaining equilibrium between demand and supply of money by an appropriate monetary policy. 4. Free from Cyclical Effects: The paper standard is free from the effects of business cycle arising in other countries. This merit was not available to other monetary standards, especially the gold standard, where cyclical movements in one country were automatically passed on to other countries through gold movements. 5. Full Utilisation of Resources: The gold standard had a deflationary bias where by the resources of the country remained unutilised. Whenever there was gold out of flow, the prices fell and resources became unemployed. But this is not the case under the paper standard in which the necessary authority can manipulate the monetary policy in order to ensure full utilization the countrys resources.

 6. Equilibrium in Exchange Rate: One of the merits of the paper standard is that it immediately restores equilibrium in the exchange rate of a country whenever disequilibrium occurs in the demand and supply of its currency in the foreign exchange market. 7. Portable: It is very convenient to carry large sums of paper money from one place to another. 8. Easy to count: It is easier count paper money than metallic money. 9. Easy to store: It is easier to store large sums of paper money in a small space. 10. Cognisable: It is easy to recognise paper notes of different denomination. 11. Replaceable: Paper notes of one type and denomination can be easily replaced by printing notes on different types of the same denomination.

DISADVANTAGES OF THE PAPER CURRENCY STANDARD

1. Inflationary Bias: One of the serious defects of the paper standard is that it has an inflationary bias. As paper notes are inconvertible, there is every likely hood of the government printing note in excess of requirements. Or the government may deliberately resort to the printing press to meet a financial emergency or war or even to need ordinary budget deficits. This leads to excess of money supply and to inflation in the country. 2. Price Stability a Myth: In the merits of the paper currency standard it has been pointed out that it leads to price stability. Actually price stability is a myth as has been experience of the majority of the countries on the paper standard.

 3. Exchange Instability: Another disadvantage of this system is that it leads to instability in exchange rates whenever there are large fluctuations in external prices an against internal prices. Such wide and violent fluctuations in exchange rates are harmful for the growth of international trade and capital movements among countries. These have led governments to adopt exchange control measures. 4. Lacks Confidence: Paper money lacks confidence as it is not backed by gold reserves. 5. Lacks Durability: Paper money has less durability than metallic coins. It can be easily destroyed by fire or insects.

 6. Unstable: Paper money lacks stability because its supply can be changed easily. 7. Uncertainty: Instability in the value of paper money leads to uncertainty in the economy which adversely affects business and economic progress of the country, 8. Token Money: Paper money is token money and in the event of demonetisation of notes they have no intrinsic value and are simply like wrote papers. 9. Not Automatic: The paper currency standard does not operate automatically. It is highly managed standard which requires much care and caution on the parts of the monetary authority. A little carelessness may bring disaster to the economy.

Merits of paper currency standard Stability in the internal price level Freedom in management Ensures full employment of resources Elasticity of money supply More suitable for national emergencies Demerits of paper currency standard Danger of inflation Instability in international prices Instability of exchange rates

Principles of Note issue

Currency principle Banking principle

Greshams Law
According to Gresham, bad money tend to drive good money out of circulation. Gresham has tried to explain the theory in other words elsewhere as , other things being equal ,when in a country two or more kinds of money circulates at the same time ,bad money drives good money out of circulation .

Quantity theory of money

The quantity theory of money aims at explaining the factors that determine the general price level in a country. It pinpoints those causes which bring about changes in the value of money. Theory states that the price level or the value of money is determined by the supply of money. The value of money is according to this theory ,varies inversely as the supply of money , the price level on the contrary , varies directly as the quantity of money . At present there are 2 versions of the quantity theory of money : the transactions approach The cash balance approach

 The Transactions Approach Fishers version Propounded by Irvin Fisher The Purchasing Power of Money . According to Fisher , the purchasing power of money ( or the value of money ) depends upon the quantity of money relatively to the amount of goods and services to be purchased. MV=PT M= Total quantity of money in circulation . V= Velocity of circulation of money ( Avg. Number of times each unit of money is spent on purchase of goods and services) P= general price level T = total volume of transactions. Thus equation implies that the quantity of money determines the price level; the price level in its turn varies directly with the quantity of money.

MV=PT P=MV/T MV= supply of money / total money exp PT= demand of money / (Total value of all goods and services transacted during a given period of time.) Fisher said that in a country during any given period of time , the total quantity of money (MV) will be equal to the total value of all goods and services bought and sold (PT).

 It should however be noted that in the above equation only primary money or currency money has been included. But money in the modern economy is limited not only to primary money but it also includes banks demand deposits or credit money as well. It was on account of the growing importance of bank deposits or credit money that Fisher later extended his equation of exchange to include credit money.

 Fisher Represented demand deposits in the banks or credit money ) by M and the velocity of circulation of credit money by V. Thus MV+MV=PT P=(MV+ MV)/T M= quantity of money in circulation V= velocity of circulation of money M = volume of bank credit money V= velocity of circulation of bank credit or credit money T= volume of trade. Price Level ( P) is directly related to M, V, M and V. Its however inversely related to T.

CRITICISM OF THE QUANTITY THEORY OF MONEY:

Fishers quantity theory has been criticised on the following grounds : (1) Variables are not independent : As assumed by Fisher, the various variables in transactions equation are not independent. For example, increase in the volume of trade (T) may lead to increase in the money supply (M) and increase in the velocity of money. Again change in the price level (P) influences money supply. (2) A simple truism : Fishers equation of exchange is a simple truism and it proves nothing. (3) Unrealistic assumption of long period : Fishers quantity theory of money has been criticised on the ground that it provides a long term analysis of value of money. (4) Unrealistic assumption of full employment : Keynes criticised this theory as it was based upon the unrealistic assumption of full employment. Full employment is a rare possibility in the actual world. (5) State theory : Fisher assumes some variables (V. T. etc.) of the equation remains constant. The assumption of constancy of these variables makes the theory a static theory. (6) Technically inconsistent : Prof Halur considers that Fishers equation of exchange is technically inconsistent. M and V in the equation of exchange are non-comparable factors and cannot be multiplied together. Hence the left-hand side of the equation MV = PT is inconsistent.

(7) Fails to explain trade cycles : The quantity theory of money does not explain the impact influence of cyclical fluctuations in the change in prices. (8) Ignores the store of value function of money : The quantity theory of money considers that money is used only as a medium of exchange. It completely ignores the importance of money as a store of value. (9) Concept of velocity of money not discussed : The quantity theory of money does not discuss the concept of velocity of money in circulation. It does not explain the factors influencing it. (10) No direct and proportionate relation between M and P. : According to Keynes there is no direct and proportionate relationship between the quantity of money (M) and the price level (P) as is stated in the quantity theory of money. (11) Other determinants of price level ignored : The quantity theory of money maintains that price level is determined by the factors included in the equation of exchange, i.e., by M, V and T. But there are some other determinants of prices also, such as income, expenditure, saving, investment, consumption, population, etc. (12) The theory is one-sided : Fishers quantity theory of money is one-sided. The theory takes into account only the supply of money and its effects. It assumes that demand for money remains constant. (13) A redundant theory : The critics maintain the quantity theory as redundant and unnecessary. There is no need of a separate theory of money. Because, like all other commodities, the value of money is also determined by the forces of demand and supply of money. Hence, the general theory of value can also be extended to explain the value of money. (14) Crowthers criticism : The quantity theory of money has been criticised by Crowther on the ground that it explains only how it works of the fluctuations in the value of money and does not explain why it works of these fluctuations.

 The Cambridge equation first appeared in print in 1917 in Pigou's "Value of Money". Keynes contributed to the theory with his 1923 Tract on Monetary Reform. The Cambridge economists Marshall Pigou, Robertson and Keynes developed cash balance approach to the quantity theory of money. It is an improved design of Fisherian quantity theory of money put forward by an American economist Irving Fisher. The Cambridge cash balance approach considers the demand for money not as a medium of exchange but as a store of value. According to the cash balance approach, the value of money is determined by the demand for and supply of money.

The demand for money is the determination of the people to retain the purchasing power to obtaining goods and service at a particular moment of time. The demand for money , according to the Cambridge economists ,arises out of the liquidity preference of the people . The demand for money or cash balances thus is induced by household and businesses to keep the wealth in the form of money to pay for the goods and also to hold assets in liquid form so that they can meet any unexpected and unforeseen developments. The demand for money is a certain portion of annual national income which people want to hold in cash or in the form of money for the transaction and precautionary motives. In reality ,every individual prefers to hold his assets as far as possible in the most liquid form . In economic terminology ,this desire of the individual is referred to as his liquidity preference . According to the Cambridge Economists ,the higher the liquidity preference of the people ,the greatest the demand for money. On the contrary ,the lower the liquidity preference ,the lower the demand for money on the part of the people .

 According to the Cambridge economists ,the supply of money is its stock at a particular point of time rather than its flow over a given period of time. The supply of money at a particular moment comprises all the cash and bank deposits subject to withdrawal by cheques. Since the supply of money at a particular moment of time is fixed therefore the changes in the price level depends upon the changes in demand for holding money or cash balances.

 The Cambridge cash-balances equations of Marshal, Pigou, Robertson and Keynes are stated as under : Marshalls Equation The Marshallian cash-balance equation is expressed as follows : MV = KPY Where M is the supply of money (currency plus demand deposits) P is the price level Y is aggregate real income; and K is the fraction of the real income which the people desire to hold in the form of money. The value of money (1/p) (or, the purchasing power of money), in terms of this equation, can be found out by dividing the total quantity of goods which the people desire to hold out of the total income (KY) by the total supply of money (M). Thus,

Similarly, the price level (P) can be found out by dividing the total money supply (M) by the quantity of goods which the people desire to hold out of the total income (KY). Thus,

Thus, for example, if M is Rs. 10,000, Y is 1,00,000 units, K is .5, then the value of money (1/p) will be 1/P= KY/M P= .5*100000/10000 = 5 units of goods per rupee . P= M/KY = 10000/5*100000 = 1/5

(i) the price level (P) is directly proportional to the money supply (M); (ii) the price level (P) is indirectly proportional to the aggregate real income (Y) and the proportion of the real income which people desire to keep in the form of money (K); (iii) M and Y being constant, with the increase in K price level (P) falls and with the decreass in K price level (P) rises; (iv) K and Y remaining unchanged, if supply of money (M) increases, price level (P) rises and if supply of money (M) decreases, price level (P) falls.

Pigous Equation
P= KR *{C+h (1-C)} M P= purchasing power of money R= Aggregate real income K= Represents that total money stock or total cash held by a particular community. M= Represents the total money stock or total cash held by a community. C= is the proportion of money which the public keeps in the form of legal tender. h= represents the proportion of cash reserves deposits held by the banks 1-C= implies that proportion of total money which is held by the people in the form of bank deposits .

Robertson's Equation
P= M/KT P= price level M= supply of money T= total amount of goods and services to bought during one year . K= that proportion of T which the people desire to hold in the form of cash.

Keynes Equation
P= n/k+rK n=is the total supply of money in circualtion P= is the general price level K= is the total quantity of consumption units which the people decide to keep in the form of cash . r= represents the ratio of banks cash reserves to their deposits K=indicates the number of consumption units the community decides to hold in the form of bank deposits .

Income theory of Money

Saving and Investment theory of money because it studies both saving and investment in the context of determination of the price level. The credit for the income theory is generally given to Lord Keynes ,although the theory in its original form was presented in 1844 by Thomas Tooke( An enquiry into the currency Principle ) .

 The money income theory said that changes in the aggregate demand are the resultant of changes in income rather than money supply. The theory clearly asserts that the aggregate demand for goods and services are determined by the size of the money income of the community. An increase in money of income of the community. An increase in money income of the community implies larger purchasing power in the hands of people who will spend it on buying larger quantities of goods and services than before. The demand for goods and services will go up.

 If the production is not sufficiently elastic on account of the existence of bottlenecks the increase in money income, will leads to increase in aggregate demand which will raise the price level in the economy. If on the contrary , production is highly elastic then an increase in money income will not have much effect on price level because the increased aggregate demand will be met by increasing the level of production and employment.

The term income in this theory is expressed in 2 sensesMoney income Real income Money income of a community in any period of time may be defined as the monetary value of the total output of goods and services produced during that period. Y= C+S Y= Income S= saving C= consumption The real income means the aggregate output of goods and services in a community during a given period of time.

Expenditure is incurred on 2 types Consumption goods ( Consumption exp ) Investment goods( Investment exp ) The former is determined by the level of real income ( output of goods and services ) and propensity to consume of the income receiver. The latter is determined by the marginal efficiency of capital ( profitability of capital ) and the current rate of interest . Y= C+I

P= Y/O P= general price level Y= money income O= total output of goods and service . The general price level will register a rise if the money income rises more rapidly than the total output of goods . The general price level on the contrary will record a fall if the total output of goods and services more rapidly than the money income. Y= C+I Y= C+S I= Y-C S=Y-C I=S

 According to Keynesian theory , the economy will be in a state of equilibrium if saving is equal investment, because what the community withdraws from the aggregate income in the form of saving it adds to it in the form of investment expenditure.

Reflation
Prof. Cole , Reflation may be defined as inflation deliberately undertaken to relieve a depression. Reflation is a type of controlled inflation. When deflation is carried to an extreme limit and the prices of goods an services fall to extremely low levels ,then the government may resort to reflation to protect the economy of the country from serious consequences . The government then expands the money supply with a view to pushing up the prices to the normal level.

DEFLATION
Deflation is that state of the economy where the value of money is rising or the prices are falling. Defect-sometimes the price level starts falling down without any contraction in the supply of money. Now such a fall in the price level cannot be called deflation. Deflation may refer to that state of the economy where the supply of the money at a particular time is less than its demand . Defects it does not tell us how to make an accurate estimate of the money requirements of the economy.

 Deflation is that state of falling prices which occurs at that time when the output of goods and services increases more rapidly than the volume of money income in the economy. Thus every fall in the price level is not deflation. Deflation occurs at that time when the output of goods and services increases more rapidly than the volume of money income in the economy.

 A fall of prices in the following situations may be termed deflationary according to Pigou: If the money income diminishes but the output remains constant. If the money income and output both diminish but thee money income diminishes much more rapidly than the output. If the volume of output increases but the money income remains constant. If the volume of output and money increases but the output increases faster than the money income. If the volume of output increases but the volume of money income diminishes .

EFFECTS OF DEFLATION
Producers and traders Investors Salaried and labor classes Consumers Debtors and creditors

Producers and traders the producers are affected on 3 points 1. The production costs at a time of deflation do not fall as fast as the prices of the finished products . 2. Wherever a producer buys raw materials etc they have to give higher price for it but they have to sell at lower price when the finished goods reaches to the market . 3. The demand for commodities also goes down at a time of deflation. Investors there are 2 types of investors 1stly ,those investors whose income is fixed. 2ndly those investors whose income is variable . The fixed income investors are true gainers because their income is constant while the prices continue to fall as a consequence of deflation. Where as variable income investors are badly affected by deflation. ( dividends and market price of shares are going down).

 Salaried and labor classes these class people are mostly benefitted from deflation . With the fall in prices ,it is not easy to cut down wages of the workers( trade union pressures ) but the prices of the goods are going down. But people working in the smaller units suffers because smaller units have to reduce the production of goods due to which retrenchment of the workers will take place. Consumers Fixed income consumers are benefitted from the deflation .But consumers whose income is variable ( goes down during deflation) suffers because their incomes goes down during deflation where as fixed income consumers have fixed income and as the prices of the goods are going down which increases the purchasing power of the fixed income consumers.

 Debtors and creditors creditors gain while the debtors lose because of deflation. The creditors gain because whatever amount they receive in the form of interest carries now a higher buying power than before. The creditors also gain because at a time of deflation ,the demand for consumption loans goes up and the creditors can charge higher rates of interest on them. But the debtors are the losers at a time of deflation.

Measures of controlling deflation

Monetary measures Deficit financing Lower rediscount rates Lower reserve requirement Expansion of credit Fiscal measures Cutback in taxation Rise in public outlay Equitable distribution of good and services(poor) Repayment of public debt Endowment of subsidies

Disinflation
Disinflation may be defined as the process of reversing inflation without creating unemployment or reducing the output in the economy. Disinflation is an attempt to cure a highly inflationary situation. whenever there is excessive supply of money and the prices start rising to higher and higher levels, then the govt. may resort to a policy of disinflation to bring the prices down to the normal level.

Bottleneck inflation
In an underdeveloped economy ,due to the limited and inelastic supply of resources, increases in the money supply invariably result in a rise in the price level. Keynes call it as bottleneck inflation, which sets in even before the point of fullemployment is reached.

Stagflation
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 Inflation is unjust and deflation is inexpedient