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(a) Distinguish between money, near money and money substitutes. (b) Identify and explain the functions of...

(a) Distinguish between money, near money and money substitutes.

(b) Identify and explain the functions of money. (6 marks)

(c) Explain the reasons for liquidity preference for money.

(d) Explain any four qualities of money.

Answers

Peter
(a) Money refers to anything which is widely acceptable in exchange for commodities, or in setting debts not for itself but because it can be similarly passed on.

Near money refers to wealth held in a form that may be quickly and easily changed into money. Building society deposits may be considered as being in this category. Near money does not possess the medium of exchange property since it has to be converted into money to be used to make payments.

Money – substitutes refer to claims to money which are convertible at face value on demand. They relate to anything generally known to be freely and readily exchangeable into money proper (money in the narrower sense) whether or not a legal requirement to do so exists. Money substitutes include token money, money-certificates and fiduciary media.

(b) The following are the main functions of money:

(i) Medium of exchange
Money facilitates the exchange of commodities in the economy. Its use greatly eases the carrying out of everyday transactions. Individuals accept money as payment for their wages because money can be exchanged for all the commodities they need.

(ii) Unit of account
Money provides a means by which one can measure the different items which make up the economy. Money therefore provides a common measure which enables one to compare different commodities and aggregate their value. Money is also the unit used in the accounts of all businesses.

(iii) Store of value
Money enables individuals to postpone their purchases to a convenient future time by providing them with a means of storing their purchasing power. Money held for this purpose is a perfectly liquid asset given that individuals can convert it at will to goods and services.

(iv) Standard of deferred payment
In this case, money facilitates the extension of credit by specifying the unit for future payment. The debt can therefore be expressed in money terms. Examples of contracts that involve future payment include hire purchase and mortgages.

(c) Liquidity preference refers to the desire to hold money rather than other forms of wealth such as stocks and bonds. Liquidity preference can be thought of as stemming from the following sources:

(i) This relates to the holding of cash by people or firms in order to
finance foreseeable expenditures. The amount of money held for this purpose depends on the individual’s money income, and institutional arrangements such as how frequently the individual is paid.

(ii) The precautionary motive: This relates to the factor that causes people or firms to hold a stock of money in order to finance unforeseen expenditures such as illness or a car breakdown. These aspects of demand for money is also likely to depend on the level of money income. T may, in addition, be influenced by the rate of interest.

(iii) The speculative motive: This relates to the reason which causes people or firms to hold money in the belief that a capital gain or the avoidance of a loss can be achieved by doing so. Thus, for example, when the price of a bond falls, the attraction of holding them increases since people will expect their price to rise again such that anyone owing them can make a capital gain. When the price of bonds is high, on the other hand, they will believe that their price could fall and will therefore hold more money.

(d) The following are the qualities that an asset should have in order to function as money:

(i) Acceptability: Money should be readily acceptable.

(ii) Durability: Money should possess the quality that it does not wear out quickly. This may to some extent be a problem with paper money.

(iii) Homogeneity: Money should be uniform as far possible. This factor relates to money of the same denomination.

(iv) Divisibility: It should be possible to divide money into smaller units so as to facilitate a variety of transactions.

(v) Portability: Money should be easy to transport. In modern banking systems deposits can be transmitted electronically even between very distant places.

(vi) Stability of Value: Money should be able to retain its value. This may be especially difficult to achieve during times of high inflation.

Musyoxx answered the question on March 16, 2018 at 17:47

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