3.1. Money as a Medium of Exchange

The use of money spans a very large part of our everyday life. Look around you and you would easily be able to identify several transactions involving money in any single day. Can you make a list of these? In many of these transactions, goods are being bought and sold with the use of money. In some of these transactions, services are being exchanged with money. For some, there might not be any actual transfer of money taking place now but a promise to pay money later.

In our daily lives, we encounter numerous transactions where money plays a crucial role. Money makes it possible to buy goods and services efficiently. Unlike barter systems, where goods are exchanged directly without any intermediate medium, money simplifies these exchanges. It allows people to engage in transactions even when there is no immediate exchange of money, thanks to promises of future payments.

Imagine you go to a grocery store and buy fruits and vegetables. You pay the cashier in cash or using a debit/credit card. This is a standard exchange of goods for money. Now think about a scenario where you promise to pay your friend for lunch next week—no cash changes hands right now, but there is a trust-based arrangement that money will be exchanged later.

Have you ever wondered why transactions are made in money? The reason is simple. A person holding money can easily exchange it for any commodity or service that he or she might want. Thus everyone prefers to receive payments in money and then exchange the money for things that they want. Take the case of a shoe manufacturer. He wants to sell shoes in the market and buy wheat. The shoe manufacturer will first exchange shoes that he has produced for money, and then exchange the money for wheat.

The concept of 'double coincidence of wants' is essential in understanding why money is used. In a barter system, for a transaction to occur, both parties must have what the other desires. Money eliminates this complication. With money, the shoe manufacturer can sell shoes to anyone (who is willing to pay money) and then use that money to buy wheat. This saves time and effort required in finding a trading partner who has the exact goods you want to exchange.

Consider trying to exchange your old video game for a new book. In a barter system, you would need to find someone who wants exactly what you have and has the book you want. With money, you can sell your video game for cash and then use that cash to buy the book from someone else without needing a direct trade.

We have seen that money is something that can act as a medium of exchange in transactions. Before the introduction of coins, a variety of objects was used as money. For example, since the very early ages, Indians used grains and cattle as money. Thereafter came the use of metallic coins — gold, silver, copper coins — a phase which continued well into the last century.

Money has evolved over time from physical objects to more abstract forms. Initially, items like grains and livestock served as money because they had intrinsic value. As societies developed, they moved towards using metals like gold, silver, and copper, which were durable and represented value more universally. This evolution paved the way for our modern currency system, where money no longer has intrinsic value but represents value because of government backing.

Think of how we use money today. Your credit card or mobile payment app doesn't contain physical cash; instead, it represents money that’s stored electronically. Just like cattle were valuable in ancient times, the balance in your bank account is what gives you purchasing power in today's economy.

Modern forms of money include currency — paper notes and coins. Unlike the things that were used as money earlier, modern currency is not made of precious metal such as gold, silver and copper. And unlike grain and cattle, they are neither of everyday use. The modern currency is without any use of its own. Then, why is it accepted as a medium of exchange? It is accepted as a medium of exchange because the currency is authorised by the government of the country.

Modern currency, unlike its predecessors, is not made of anything valuable itself. For example, a 100 rupee note is just paper but is accepted everywhere because the government guarantees it as legal tender. This means that it can be used to pay for goods and services, and others are obliged to accept it.

Think of playing a game where you exchange game tokens for rewards. The tokens have no intrinsic value outside the game, but because everyone agrees to accept them for trading within that game, they facilitate all transactions. Similarly, the government supports the value of modern currency in the economy.

The other form in which people hold money is as deposits with banks. At a point of time, people need only some currency for their day-to-day needs. For instance, workers who receive their salaries at the end of each month have extra cash at the beginning of the month. What do people do with this extra cash? They deposit it with the banks by opening a bank account in their name.

Demand deposits are funds that people keep in bank accounts and can withdraw as needed. This system allows money to be held securely while also earning interest, making it a smart choice for people who do not need immediate access to all their cash. It’s convenient for everyday transactions, from paying bills to making purchases.

Imagine you receive your salary and don't want to keep all that money at home. Instead, you deposit it into your bank account. This way, you secure your funds while also allowing them to grow through interest, plus you have easy access whenever you need some cash.

For payment through cheque, the payer who has an account with the bank, makes out a cheque for a specific amount. A cheque is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued.

Cheques allow for safe and efficient transactions without needing to carry cash. When a person writes a cheque, they authorize their bank to pay a specified amount to the recipient’s bank account. This mechanism ensures that money is transferred securely and efficiently, also leaving a record of the transaction.

Think of writing a cheque like sending an email instead of mailing a letter. Both get a message to the recipient, but a cheque is more secure and efficient than carrying wads of cash. When you write a cheque, you make sure the recipient receives exactly what you owe them safely.

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