Money and banking

Economics · Microeconomic decision-makers. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Money is anything that is generally accepted as payment for goods and services. Without it people must barter, which needs a double coincidence of wants: each person must have what the other wants.

Money does four jobs (its functions) and needs certain qualities (its characteristics) to do them well. Today money takes the form of notes, coins and bank deposits. Most money is bank deposits.

A commercial bank aims to make a profit. It accepts deposits, lends to households and firms, and lets customers make payments. The central bank is the government's bank and the bankers' bank. It issues notes and coins, sets the interest rate and supervises the banking system.

Rules to remember

Functions of money: medium of exchange, unit of account (measure of value), store of value, standard for deferred payments
Characteristics of good money: generally acceptable, durable, portable, divisible, limited in supply, recognisable
Forms of money: notes, coins and bank deposits. Shares, property and goods are assets, not money
Commercial bank profit: the interest rate charged on loans is higher than the interest rate paid on deposits
Central bank functions: issues currency, banker to the government, banker to commercial banks, lender of last resort, carries out monetary policy, holds the country's foreign currency reserves, supervises banks
Lender of last resort: the central bank lends to a commercial bank that is short of cash and cannot borrow elsewhere, which keeps trust in the banking system

Common mistake

Giving characteristics when the question asks for functions. Functions are the jobs money does (such as store of value); characteristics are the qualities it needs (such as durable and divisible).

Worked example

A nurse puts part of her wages in a bank account each month so that she can buy a motorcycle next year. Which function of money is she using, and what could weaken it?

She is not spending now: she is keeping purchasing power to use later.
Keeping wealth in the form of money for future use is the store of value function.
If prices rise quickly, the same rupees buy less next year, so inflation weakens this function.

Answer: Store of value. High inflation would weaken it, because the money saved would buy less in the future.

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