Question

List and explain the logic behind the 'four functions of money. Then consider the following: In many prisons, cigarettes are used as money. Do cigarettes in prison have the ability to satisfy these four functions?

Answer 1

The four functions of money are -

1.Medium of Exchange -

Money, as a medium of exchange, means that it can be used to make payments for all the transactions of goods and services. It is the most essential function of money. Money has the quality of general acceptability. So, all exchanges take place in terms of money.

* This function has removed the major difficulty of lack of double coincidence of wants.

2. Measure of unit (unit of value)

Money as a measure of value means that money works as a common denomination, in which values of all goods and services are expressed.

* By reducing the value of all goods and services to a single unit (i.e. price), it becomes very easy to find out the exchange ratios between them and comparing their prices.

3. Standard of deffered payments-

Money as a standard of deffered payments means that money acts as 'standard' for payments, which are to be made in future. Everyday, millions of transactions take place in which payments are not made immediately. Money encourages such transactions and helps in capital formation and economic development of the economy.

* Money as a standard of deffered payments has simplified the borrowing and lending operations and it has led to the creation of financial institutions.

4. Store of value

Money as a store of value means that money can be used to transfer purchasing power from present to future. It provides security to individuals to meet contingencies, unpredictable emergencies and to pay future debts. Under barter system, it was difficult to use goods as a store of wealth due to perishable nature of some goods and high cost of storage.

* Money is easily portable and generally acceptable. So it is easy to store money and it can be generally exchanged for goods at all times.

Cigarettes is use as money in some prisons because it has some worth of money in prison. Cigarettes serve as a medium of exchange as prisoners can exchange the other goods for cigarettes. They are serve as unit of value as the price are quoted in terms of the number of cigarettes required for exchange. Cigarettes serve as store of value as cigarettes can be stored in present to meet the future needs of prisoner.