Functions of Money

Last Updated On -20 Jun 2025

Among the most essential creations in human history is money. Without it, trade would still rely on the ineffective and limited barter system whereby items were traded for other items. Money filled the void as economies developed and grew since a uniform medium of exchange became essential. From the smallest family to the biggest multinational corporation, money serves numerous basic purposes that propel every modern economy, not only a tool for buying and selling.

Knowing the purposes of money enables us to appreciate the dynamics of economies and the reasons behind the current arrangement of financial systems. Let's examine, in particular, the primary functions that money performs in macroeconomic systems and daily life.

What are the Key Functions of Money?

Money drives every transaction, investment, and economic policy; it is not only a sign of riches. Any economy depends on its medium of exchange, store of value, value-measuring tool, and standard of deferred payment to function correctly. Understanding the fundamental purposes of money becomes increasingly essential for commerce students, economists, and business leaders as financial systems become more complicated with the emergence of digital money and fintech.

1. Middle of Exchange

Money's most fundamental and well-known use is as a means of trade. It removes the basic restriction of barter, the need for a twofold coincidence of wants, thus facilitating transactions between buyers and sellers.

Under a barter system, commerce can only take place when two people simultaneously have something the other wants, a highly ineffective situation. Money acts as a middleman in exchanges, thereby resolving this issue. When you buy groceries, for instance, you don't have to look for a shopkeeper ready for your return of services. Instead, you utilize money as a generally agreed-upon medium of exchange that both sides value and trust. In contemporary economies, this ability is what enables specialization and extensive trade.

2. Value Measure: Unit of Account

Standard units of measurement for the worth of products and services are money, so commerce and economic comparison are far more sensible and practical.

Comparatively evaluating the value of several products is tricky without a benchmark. Imagine a day when you had to know how many kilograms of rice matched one school bag or how many loaves of bread equaled one book. Money simplifies this by giving a constant unit, such as rupees, dollars, or euros, to measure and compare values. This also helps companies set prices, maintain accurate records, and evaluate their earnings. Accurate and open financial communication in accounting, budgeting, and taxation depends on the unit of account function.

3. Value Store

Furthermore, serving as a store of value, money can help retain purchasing power over time. Under at least stable economic times, you can hold money now and use it later without losing its value.

This feature allows people to set aside a portion of their salary for future use. Someone can save their money and use it later on if they make it today but do not need to spend it all right away. This runs counter to perishable items, such as fruits or vegetables, which cannot retain their value over time. But inflation, where the value of money loses over time, may undermine the store of value function of the system. Still, in contemporary economies, money is the most liquid and often used form of value.

4. Standard of Postponed Payment

Future payments and debt settlement usually follow money as the benchmark. In credit-based economies, where transactions often span a period between agreement and settlement, this is crucial.

Money forms the basis for deciding on a loan or credit purchase repayment period and amount when you apply for either. Both sides know and believe the money owing will be valuable and accepted upon payment later.

For example, borrowing ₹50,000 now means that the same unit, money, will be utilized for repayment over a designated term. Fundamental to modern business, this ability enables contracts, credit markets, and financial instruments.

5. Ground of Credit System

Closely associated with postponed payments, money is the foundation of the credit system. It helps businesses, including banks and financial firms, to lend and invest in various sectors of the economy.

Banks give loans to governments, companies, and people, as well as take money as deposits. By funding consumption and investment, this system lets nations flourish. Credit cards, mortgages, business loans, all of which exist, because of the stability and acceptability of money. It also guarantees that financial intermediaries can provide loans with confidence, knowing that repayment will be made in a generally acknowledged manner.

6. Values Transfer

Money enables one person, area, or nation to effectively distribute purchasing power to another, thereby promoting global resource distribution.

Money enables the easy transfer of wealth, whether it's investments made from one state to another or remittances transferred from workers abroad to their families back home. It offers a neutral, dependable medium that can be delivered digitally, physically, or even through intricate banking systems, thereby transcending the limitations of bartering in many markets.

Did you know?

Not coins or notes but commodities like shells, salt, or livestock. The first known form of money was Large stone discs known as Rai stones, which were employed as money in some societies, even though they were so massive they couldn't be transported!

Frequently Asked Questions (FAQs)

With which use of money does barter become unnecessary?

A significant problem in a barter system is that the medium of exchange does not solve the twofold coincidence of needs issue.

Can money still be a store of value during inflation?

Not very well. Unless invested in interest-bearing or inflation-protected assets, the value of money erodes under high inflation, therefore lessening its efficacy as a store of value.