Money: Meaning and Definition | Four Functions of Money

Definition and Meaning of Money

Money is a medium of exchange that is generally acceptable to people as a unit of exchange and as a store of value. 

Generally, currency notes and coins are considered money by the public. 

But money can be any instrument with some purchasing power and can be stored for future use.

The great economist Geoffrey Crowther, who was the editor of a newspaper, "The Economist" during the 1930s and 1940s and later became the Managing Director and Chairman of The Economist Newspaper Ltd., defined money in his book "An Outline of Money" as follows:

"Anything that is generally acceptable as a means of exchange and which at the same time acts as a measure and store of value".

So, money is anything that is legally and socially acceptable for buying and selling goods and services or for making payments, or for the repayment of debts.

The Importance of Money

Money plays a crucial role in economics. 

It serves as a medium of exchange for goods and acts as a unit and store of value for executing transactions. 

Without money, obtaining goods and services would be much more difficult. 

In the ancient barter system, individuals had to find someone who was willing to exchange their goods for what they needed. This meant that both parties in the barter system had to have products that the other desired, creating a challenge in matching needs and offers. 

However, in today’s money economy, there is no need to search for someone who wants your product in exchange for what you need. You can sell your product directly in the market and receive money in return. With that money, you can purchase whatever you require. 

Using money simplifies transactions. 

You can buy goods or services whenever it's convenient for you, pay your bills, deposit money in banks for future use, transfer it anywhere in the world, and access it as needed. This illustrates the significance and benefits of money in our lives.

Four Functions of Money in the Economy

Money performs four major functions:
1) Money is the medium of exchange.
2) Money is a unit of account and measure of value.
3) Money functions as a store of value.
4) Money is a standard of deferred payments.

Among the four functions of money, the medium of exchange and measure of value are considered the primary functions. 

The store of value and standard of deferred payment are viewed as secondary functions, as they are derived from the primary functions.

Primary Functions of Money:

1) As a Medium of Exchange:
Money is a medium of exchange in the sense that it is used to exchange for goods and services. The buyer purchases goods and services and pays money for them. The seller sells goods, and the service provider provides services, and in both cases, they receive money from the buyer. Thus, money is an important medium for their transactions.

For example, you buy a chocolate and pay money for it. The seller of chocolates receives money in exchange for his chocolate. 

Similarly, you get the services of a barber to shave your beard, and in exchange, you pay money. The barber provides the service and receives money. 

Thus, money serves as an important medium of exchange in all transactions.

2) A Measure of Value or Unit of Account:
Money acts as a unit of account or measure of value. You value goods and services in terms of their monetary value. You are fixing monetary value per one unit of a good or service. 

So, any goods or services that we buy or sell are quoted in their value/ per unit.

For example, a chocolate is quoted at Rs 5, a loaf of bread at Rs 50, and a computer at Rs 20,000. Similarly, one shave is quoted at Rs 50, one haircut at Rs 100, and one car wash at Rs 200. 

When you give a value to a unit of a good or service, it becomes very easy to identify those goods and services and compare them with other similar products or services offered by different sellers or providers.

Secondary Functions of Money:

1) Money as A Store of Value:
Money can be stored and used subsequently without losing its value for a certain period. Money can be used only when you need to buy or procure something. Till then, you can keep your money in your purse or wallet, or deposit it in your bank account. 

Money gets stored for your future needs. 

With that, you can buy anything like rice, bread, chocolate, wheat flour, a car, a computer, and so on in the future, whenever you need them. 

Thus, you are storing the purchasing power of money for a certain period, until you actually need those goods or services. 

You are much more relaxed as you know that you can purchase anything with the stored value of money. This is one wonderful function performed by money.

This function of money is the result of its primary functions as a unit of account and as a medium of exchange. It is because of those two functions that you are capable of storing money. 

It is because money is generally accepted as a medium of exchange that you are keeping it in store. 

It is because of the fact that it is a unit of transaction that you are procuring different denominations of money and using them for your purchases.

2) Standard of Deferred Payments
Money functions as a standard for deferred payments. When someone borrows money from you and agrees to return it after a certain period, he will pay it back in the form of money on that stipulated date, along with interest, if any, charged by you for lending him the money instead of using it for other useful purposes by you. Millions of transactions are taking place now, which are not paid immediately.

Payments get deferred till a certain period of time or till the happening of a certain event or till the actual goods or services reach you. So, till such period, the payment gets postponed or deferred, and nobody worries as money will not lose its value even if paid later under normal circumstances. 

You defer the payment because of the standard value of money and its general acceptability. 

This function of money has given rise to various financial institutions and lending businesses and thereby advanced economic development.

Definition and Explanation of Producer Equilibrium - Different Approaches to Producer Equilibrium

Just as consumers seek to maximize their satisfaction and utility by reaching consumer equilibrium, producers strive to reach a point that maximizes their profits, known as "producer equilibrium."

What is Producer's Equilibrium?

Producer's equilibrium is the point on the scale of production at which the level of production of any particular commodity yields the maximum profit for the producer of that commodity. At that point, the production cost of that commodity will be much less than the total revenue obtained through the sale of that commodity. It is the maximum possible profit that any producer can obtain at that equilibrium point.

In other words, producer equilibrium refers either to the level of profit maximisation or, otherwise, to the level of cost minimisation. 

Cost minimisation also results in profit maximisation.

Definition of Producer Equilibrium in Economics

• Producer's equilibrium can be defined as a state of economic condition that leads to the achievement of that level of output, after which no further maximization of profit is possible.
• It is the stage where there is no further inclination towards expansion or contraction of the output.
• It is a point at which there is either maximum profitability and/or minimal loss.

Different Approaches in Studying Producer's Equilibrium

There are two approaches for reaching out to producer's equilibrium:

1) the TR - TC approach and

2) the MR = MC approach.

There can be Two Types of Markets for studying producer equilibrium

a) Perfect competition market where prices remain constant and

b) Imperfect competition market where prices are either rising or falling constantly.

We need to study the equilibrium under both these market conditions.

Now, let us study the producer's equilibrium under all these different conditions, one by one.

I) Total Revenue - Total Cost (TR - TC) Approach

Under the TR - TC approach, the producer tries to attain the equilibrium point by maximising his profits to the utmost possible level. So, this implies that the TR-TC approach should satisfy the following two conditions.

• The difference between Total Revenue and Total Cost has been maximised.
• Any further effort to increase output after that point will result in a fall in total profit.

Let me explain this approach under both Perfect Competition and Imperfect Competition.

i) The producer equilibrium under perfect competition (When prices remain constant)

When prices are constant in perfect competition, the producer goes on increasing his output or sales and is able to enjoy maximum profit till a certain point, after which he may not be able to produce more without adding extra machinery or extra expenses and capital. 

The addition of capital and machinery may increase the product's costs and force him to raise the sale price or face a loss. Alternatively, he may not be able to sell more unless he lowers the price, which may also reduce profits.

So, he is forced to maintain the status quo at the equilibrium level.

Let us study the same point through the table below:

Price per unit       Output (units)      Total Revenue     Total Cost     Profit

      6                        1                          6                      5                  1

      6                        2                        12                     10                 2

      6                        4                        24                     19                 5

      6                        6                        36                     28                 8

      6                        7                        42                     34                 8

      6                        8                        48                     41                 7

From the illustration above, we can see that producer equilibrium has been achieved at the output level of 7 units, at which point you are enjoying a maximum profit of 8 dollars by producing 7 units. When you tried to increase the output by another unit, the profit decreased to 7 dollars.

The same thing can be illustrated in the form of a graph also. But I am not doing the graph.

ii) Now, watch producer equilibrium under imperfect competition (when prices are falling upon increased output )

There is no control over the prices, and each producer has his own price norms and sells products accordingly. 

But, after a certain level of output, he is forced to lower the prices as his stocks are accumulating. 

The example below illustrates this position.

Price per unit       Output (units)      Total Revenue     Total Cost      Profit

       8                       2                          16                    10                   6

       7                       3                          21                    14                   7

       6                       5                          30                    21                   9              

       5                       6                          30                    23                   7

The producer equilibrium in the above example is attained at an output level of 5 units. He was making profits at production levels of 2, 3, and 5 units.

But after the output level of 5 units, an additional unit resulted in a fall in total profit.

II) Marginal Revenue = Marginal Cost Approach (MR = MC approach)

According to this approach, producer equilibrium is attained where the marginal revenue from an additional unit of output equals its marginal cost.

This approach should satisfy the following two conditions or assumptions:

1) MC = MR

2) Marginal cost becomes higher than Marginal Revenue if one more unit of output is produced after reaching the output level of MR = MC

Let us study this approach also under both the perfect and imperfect competition conditions of the market.

i) Producer equilibrium under perfect competition (when price is constant)

When price is constant, each unit of output is sold at the same price. 

So, the average price (AR) of any particular unit is the same for every unit. 

The marginal revenue (MR) will be the same, as the prices are constant for each unit. 

So, you will enjoy producer equilibrium until there is a rise in MC or a fall in MR.

Let me illustrate this with a table as below:

Let us assume that the price is constant at Rs 6, but the cost of producing additional units differs. The MC figure shows the additional value per each additional unit.

Price (Rs.)    No.of units         TR            TC              MR            MC          Profit (TR-TC)

6                    1                     6                8                6                 8                -2

6                    2                    12              15                6                 7                -3

6                    3                    18              20                6                 5                -2

6                    4                    24              24                6                 4                 0

6                    5                    30              28                6                 4                 2

6                    6                    36              34                6                 6                 2

6                    7                    42              41                6                 7                 1

From the above, we can see that the producer was initially incurring losses, and he increased his output to eliminate them and make profits. 

When he produced 4 units, there were no losses. 

At levels of 5 and 6 units of production, he was able to make profits of 2 points. 

At 6 units of production, MR is equal to MC. When he tried to increase output by one more unit, the profit decreased again. 

So, the producer's equilibrium output is 6 units in this case.

ii) Producer equilibrium under imperfect competition (when price falls with increase in output)

When there is no perfect competition among sellers, producers and sellers try to maximize their profits by engaging in unhealthy practices. They take advantage of monopolistic opportunities and charge very high prices to gain maximum profits. 

This is workable up to a point. But when the produced quantity is much larger and identical alternative products enter the market, demand gets distributed among identical products, and each brand naturally loses demand in the long run. 

The effect will be a fall in product prices. So, too much increase in production will result in a fall in prices. In such circumstances, the producer has to decide on his maximum level of production based on producer equilibrium. He will try to match Marginal Cost with Marginal Revenue in deciding his level of production.

Let us consider an example to arrive at this producer equilibrium under fluctuating market prices.

Qty. produced   Price per unit           Total              Total       MR      MC      Profit 

                                                     Revenue           Cost                             (TR-TC)

           1                    8                        8                   6           8        6            2

           2                    7                       14                 11           6        5            3

           3                    6                       18                 15           4        4            3

           4                    5                       20                 18           2        3            2

In the illustration above, MR and MC are equal at the production level of 3 units. Beyond that level, when production increases to 4 units, profit begins to decrease because MC is higher than MR at that point. (The profit dropped from 3 to 2.)

So, the producer's equilibrium level of output is 3 units in this case.   

From the above study of producer equilibrium, we noticed two salient features:

1) Under perfect competition (where prices remain constant), Price = MR = MC, ie., the product price, marginal revenue, and marginal cost are equal to one another at the equilibrium point.

2) Under imperfect competition (where prices fall with every increase in supply or production), Price is always greater than MC or MR, as equilibrium is attained at a point where MC = MR, and marginal revenue will always be decreasing with additions of supply.