Introduction to

Money
Money & Banking –Ch. 1
 Origin and Growth of Money

Commod
Barter Metallic Paper
ity
System Age Money
Money
 Barter System
• Barter is the system of trade that was prevailing in the
economy before the invention of money.
• Commodities and good were traded directly for each
other.
• A thing in surplus can be traded for the other thing in
need of.
“Barter is the direct exchange of commodity or service for
another without the use of money.”
 Inconvenience of Barter
• Double Coincidence of Wants
If you have got surplus sugar and need a leather jacket,
you’ll have to find a man who has surplus jacket and is also
willing to give leather jacket by taking sugar.
• No Measure of Value
Lack of standard unit to measure value of different
units/goods.
• No Subdivision
As goods were traded against goods, so it was impossible to
subdivide (horse, cattle etc.) into smaller units for small
transactions.
• No Store of Value
Wealth can’t be stored for a longer period of time.
• No Investment/Savings
Neither investment, nor savings were possible in barter
system.
• No Economic Measurement
Lack of system to measure personal income (micro level) or
GDP (macro level).
• Comparison of Living Standard
Wealth can’t be stated in common units, so it was
impossible to compare living standards of different classes
of society.

• No Tax Collections
• Difficulties in transfer of wealth
• No Budgeting
• No Capital Formation
 How use of money overcome
inconveniences of Barter
• With the invention of money, the inconveniences of barter
system were removed completely.
• Money served as Medium of Exchange, Store of Value and
Unit of Account
 Medium of Exchange
• Serving as a medium of exchange, it eradicates the
inconvenience of “double coincidence of wants”.
• Now anyone can buy anything without need of searching
for a person who is in need of what you have in
abundance.
• In money economy, people sell their goods and services
for money and use that money to fulfill their wants.
• Store of Value
Now wealth can be stored in the form of bonds, share
certificates etc.

• Price Mechanism
Money established the price mechanism all across the
world. It removed the inconvenience of “no measure of
value”. The price mechanism then gave rise to market
forces of demand and supply which is the base of every
economic model today.
• Credit and Advances
• Banking Institutions
• Investment and Savings
• Public Finance and Government Revenue
• Liquidity to International Trade
• Ease of Specialization
• Foreign Investment
 The Concept of Money
• Money is defined in different form:
• “The word money has been used to designate the medium
of exchange as well as the standard of value” (N.HALM)
• “Money is anything that is commonly used and generally
accepted as a medium of exchange or as a standard of
value” (R.P.KENT)
• “Anything which is declared as money by the government
becomes money”(KNAP)
 Types of Money
1. Commodity Money
It can be thought of as the earliest form of money. In ancient
times, money was in the form of different goods that were
commonly used by people in everyday life. E.g. Iron tools,
war equipment, swords, knifes, animal teeth, fish teeth,
crops, stones etc.
• The problem was that different societies were using
different goods as money, so there was no standardized
unit of account or measure of value.
 2. Metallic Money
• Metallic money came next to the commodity money. It
consisted of different metals such as gold, silver and iron etc.
• People stared using these metals as they were scarce.
• In modern world, the coins are the form of metallic money.
• Metallic money can be further classified as;
• Full Bodied Money; Face value and intrinsic value are same
• Token Money; Intrinsic value is less than the face value.
 3.Paper Money
• Paper money means the currency notes issued by the
central bank of country.
• The origin of paper money can be traced back to the
receipts issued by goldsmiths for the deposits held by
them.
• With the advent of printing press and paper money
industry paper currency became the most economical and
famous form of money.
3.1 Representative Paper Money
• It is fully backed by gold or metallic reserves.
• It means govt. is in a position to convert all the notes into
gold if they are presented for conversion at the same time.
• Example: Receipts issued by goldsmiths
• The issuing authority always has to hold sufficient amount
of gold or other metallic reserves.
 3.2 Convertible Paper Money
• The form of money that can be converted into gold or
metallic reserves but not all the notes issued by the
government are fully backed by gold.
• Govt. knows that all people will not come for conversion at
the same time.
• Only a particular amount of gold or metallic reserves are
kept which are particular proportion of the value of notes
issued.
 3.3 Fiat Paper Money
• The one that we have got in our pocket.
• Neither it is convertible nor it is fully backed by gold or
metallic reserves.
• If you read your 100 rupee note, you will find………………
• Which means that if the note is presented to the bank for
conversion, the bank is compelled to give you Rs. 100 in
any denomination.
• The value of the paper content of that note is extremely
low (almost nill) yet it commands the purchasing power
of 100 rupees..
• That’s why it is declared as a legal tender by the govt.
and is generally accepted as a medium of exchange.
 4. Bank Money
• Bank money means near money, which is not always legal
tender but it is widely accepted as a medium of exchange.
i. Cheque
ii. Bill of Exchange
iii. Draft
 4.1 Cheque
• A cheque is a written instruction on a specified piece of
paper from a client to his bank, instructing the later to
pay a certain sum of money.
• The cheque would be “self” i.e. money is with drawn by
the client himself, or in the name of any third party.
• Types; Bearer cheque, crossed cheque, order cheque.
 4.2 Bill of Exchange
• Bill of exchange is the convenient way
to pay for commercial transaction in
credit.
• The seller instead of taking cash from
the buyer draws a bill on him which
the buyer accepts by signing it.
• Sight Bill; the payment is made on
demand.
• Time Bill; the payment is due after a
particular time period.
 4.3 Draft
• Its just like a cheque. However
the difference is that it is drawn
by a bank on its own branch or
on any other bank’s branch.
• So, drafts are the cheques used
by the banks.
• A draft when drawn on a bank,
directs it to pay a certain sum of
money to a person named on it.
 5. Plastic Money
• The credit cards and the plastic cards
which have silicon chips and a specially
printed set of characters.
• These cards are used for making
payments at ordinary shops and at the
EFTPOS (Electronic Fund Transfer at
Point of Sale).
 6. Other Forms
Beside these forms, the money can be classified into several other less
important forms.
a. Black Money; the money which has been gathered through illegal means
or prohibited ways like gambling, smuggling, crime, robbery etc.
b. White Money; which is earned through legal and legitimate means. The
holding of such money is justifiable on social, moral, legal and equity basis.
c. Cheap Money; whose cost of borrowing is less than the standard rate of
interest. In times of recession the banks are ready to lend money at a lower
rate of interest that generally prevails in the economy. Such money is
called cheap money.
 Principles and Methods of Note
Issue
• Currency Principle
• Banking Principle
 Currency Principle
• Theory
This principle is based on 100% gold backing.
According to this principle, the State bank must keep 100%
reserves against each and every note issued. So there will
be full convertibility under this system.
Mertis Demerits
Full Safety Inelastic and Rigid
100% safe as there is 100% backing. As 100% backing of gold is required so
when gold reserves are not available
central bank cannot issue notes even
though the economic situation
demands issuance of notes.
No over issue No use of Gold:
The system restricts the central It makes inefficient use of gold. Tons of
authority from over issuing the notes. gold is stored in central treasury and
Hence there’s an effective control on no effective use is made of it.
inflation.
Stability Not Suitable for Modern Economy
The 100% backing gives an element of This principle is not suitable for
stability to this system. The value of modern economy. It cannot be
the currency remains stable so enjoys effectively used in recent complex and
public confidence. rapidly changing economic situation.
Confidence
Due to stability and full safety, this
principle enjoys a complete confidence
 Banking Principle
• Theory
• This principle says that note issuance should be dealt
independently by central bank and it shall be allowed to
issue notes according to the ongoing circumstances.
• There is no need of full backing of gold under this system.
Only a percentage of issued notes are backed by gold.
• However, all the notes are issued with the guarantee of
convertibility into gold.
Merits
Elastic Supply
As there’s no restriction of 100% backing of gold, so central bank can issue notes in
response to changes in economic and monetary situation.
Economical
Only a percentage of issued notes is backed by gold, so the rest of gold can be used for
some other purpose.
Public Confidence
It also enjoys public confidence as people have trust on currency as it has been declared
as legal tender by the issuing authority.
Suitable for Modern Economy
More responsive to rapid changes of economy
Demerits
Danger of Over issue; their is tendency of over issue due to non requirement of 100%
backing of gold, which may lead to inflation that can be disastrous for the economy.
Lack of Convertibility; Bank failure may occur if all notes are presented for
conversion. However, there are rare chances of such situation.