MONEY| COMMERCE FORM III: TOPIC 4

 The Historical Background of Money

Explain the historical background of money

Commerce plays a fundamental role in the satisfaction of human wants.

In primitive societies, the producers themselves were the consumers. Hence;

they were compelled to provide themselves with foods, shelter and

clothes. Under such circumstances, the question of commercial

transactions or exchange of goods and services did not arise. But slowly

heir wants started to increase in size and in number. They were no

longer able to satisfy all their wants, so they began exchanging he

commodities produced with those produced by others.

Meaning of the Term “Barter System”

Define the term “barter system”

The exchange of goods for goods was known as barter system of trade. However, barter trade could not persist for a long period of time due to the following demerits:

Merits and Demerits of “Barter System”

Point out merits and demerits of “barter system”

DEMERITS OF BARTER SYSTEM.

• Lack of Double Coincidence of Wants:Barter
  transactions can be possible only when two persons desiring exchange of
  commodities should have such commodities which are mutually needed by
  each other. For example, if Fatma wants cloth, which Tully has, then
  Fatma should have such commod­ity which Tully wants. In the absence of
  such coincidence of wants, there will be no exchange. How­ever, it is
  very difficult to find such persons where there is coincidence of wants.
  One had to face such difficulties in barter economy because of which
  this system had to be abandoned.
• Indivisibility of some commodities:The
  second difficulty of barter exchange relates to the exchange of such
  commodities which cannot be divided. For example, a person has a cow and
  he wants cloth, food grains and other items of consumption. Under such a
  condition, exchange can be possible only when he dis­covers a person,
  who is in need of a cow and has all such commodities, but it is very
  difficult to get such a person. Then how to affect the
  exchange.Similarly the second problem relates to the exchange of such
  commodities which cannot be divided into pieces, because in this kind of
  situation, a big commodity like cow cannot be divided into small pieces
  for making payment of the goods of smaller value.
• Lack of a Common Measure of Value:The
  biggest problem in the barter exchange was the lack of common measure
  of value i.e., there was no such commodity in lieu of which all
  commodities could be bought and sold. In such a situation, while
  facilitating the exchange of a commodity its value was to be expressed
  in all commodities, such as one yard cloth is equal to ½ kilogram of
  potato etc. It was a very difficult proposition and made exchange
  virtually impossible. Now, with the discovery of money, this difficulty
  has been totally eliminated.
• Lack of Store of Value:In
  a barter economy, the store of value could be done only in the form of
  commodities. However, we all know that commodities are perishable and
  they cannot be kept for a long time in the store. Because of this
  difficulty, the accumulation of capital or store of value was very
  difficult and without the accumulation of capital, economic progress
  could not be made. It is because of this reason that as long as barter
  system continued, significant progress was not made in the world
  anywhere.

MERITS OF BARTER SYSTEM

• The
  risk of theft is lower in barter system than the risk of using money.
  Almost all modern forms of money can easily be stolen and are more
  vulnerable to theft than commodities.
• The value of commodities
  tends to be stable over a long period of tme, unlike the value of money
  which depreciates in value after a certain period of time. Due to
  depreciation in value, money plays little role as a future store of
  value.
• Barter trade is very useful in non-monetary economies,
  where money is too scarce to be used as a medium of exchange. For
  example, in rural areas barter trade is widely applied due to scarcity
  of money.

Meaning of “Money”

Give a definition of “money”

Money

is anything which is generally acceptable as a medium of exchange and

acts at the same time as a measure of value and store of value. OR Money

is anything which is generally acceptable to used as a means of

settling debts.

Qualities of Good Money

Following are the qualities of good money:

• General acceptanceThe
  essential quality of good money is that it should be acceptable to all,
  without any hesitation in the exchange for goods and services.
• PortabilityIt
  is also an important quality of good money that is should be easily
  transferable from one place to another for doing business and making
  payment. The paper money is easier to carry because it has minimum
  possible wait than metallic money.
• Storability;Money
  should be storable and it should not be depreciate with time. If the
  money used is perishable it will lose its value in few days. Paper money
  has this quality of storability.
• Divisibility;Good money is that which could be divided into small units without losing any value.
• Durability;Money
  should be durable. It should not lose its value with the passage of
  time. The gold and silver coins do not wear out quickly and quality of
  money remains the same.
• Economy;It is important
  quality of good money that it should be made economically. If there is
  heavy cost on issuing more money that is not good money. Good money is
  that has low cost and more supply. Paper money has this quality of
  economy able by a society as a medium of exchange and means of settling
  debts.

The Functions of Money

Mention the functions of money

Money

is often defined in terms of the threefunctionsorservices that it

provides. Money serves as amedium of exchange, as astore of value, and

as aunit of account.

• Medium of exchange:
  Money’s most important function is as a medium of exchange to
  facilitate transactions. Without money, all transactions would have to
  be conducted bybarter, which involves direct exchange of one good or
  service for another. The difficulty with abarter systemis that in order
  to obtain a particular good or service from a supplier, one has to
  possess a good or service of equal value, which the supplier also
  desires. In other words, in a barter system, exchange can take placeonlyif
  there is adouble coincidence of wantsbetween two transacting parties.
  The likelihood of a double coincidence of wants, however, is small and
  makes the exchange of goods and services rather difficult. Money
  effectively eliminates the double coincidence of wants problem by
  serving as a medium of exchange that is accepted in all transactions, by
  all parties, regardless of whether they desire each others’ goods and
  services.
• Store of value: In order to be a
  medium of exchange, money must hold its value over time; that is, it
  must be a store of value. If money could not be stored for some period
  of time and still remain valuable in exchange, it would not solve the
  double coincidence of wants problem and therefore would not be adopted
  as a medium of exchange. As a store of value, money is not unique; many
  other stores of value exist, such as land, works of art, and even
  baseball cards and stamps. Money may not even be the best store of value
  because it depreciates with inflation. However, money is moreliquidthan
  most other stores of value because as a medium of exchange, it is
  readily accepted everywhere. Furthermore, money is an easily transported
  store of value that is available in a number of convenient
  denominations.
• Unit of account:Money also functions as a unit of account, providing acommon measure of the valueof
  goods and services being exchanged. Knowing the value or price of a
  good, in terms of money, enables both the supplier and the purchaser of
  the good to make decisions about how much of the good to supply and how
  much of the good to purchase.

Difference between Inflation and Deflation

Distinguish inflation from deflation

INFLATION

This is persistent increase in the general price level.

Inflation rate is a rate which price increase it is expressed in terms of percentage

• Inflation rate=price in current year-price in previous year x100 / Price in previous year

For example, if the current year price for commodity X is Tsh 200 and the base year price is Tsh 100.

• =200-100×100 / 100
• =100%

Causes of Inflation

• Excessive demand for goods and services.
• When
  demand for goods increase while supply remains constant it underscores a
  rise in price and if the rise is persistent it results in inflation.
• Shortage of goods and services.
• Increase in cost of production
• Increase in government spending
• Illegal
  activities such as smuggling causes artificial shortage of goods and
  therefore rise in the prices of goods consequently inflation occurs.
• Natural calamities.

DEFLATION

This is the persistent decrease in price level.

Causes of Deflation

• Excessive supply: when supply of goods exceeds the demand for goods it cause a decrease in prices.
• Decrease in effective demand: when the effective demand for the product declines in results to the fall in the price level.
• Decrease
  in the money supply: a decrease in money supply affects the purchasing
  power of the people and leads to the fall in the price level.
• Increase
  in government revenue: when the government reduces spending on
  expenditures such as wages, security and education it affects incomes of
  the people and their purchasing power consequently a fall in the prices
  of goods and services.

Exercise 1

QUIZ

• Money is as money does.” Discuss.
• Briefly discuss barter system.