7. Money and Banking
Money is something that is generally accepted as a medium of exchange. Its main aim is to facilitate the exchange of goods and services.
Before money came into use, exchange of goods and services took place through barter system. Barter system implies the direct exchange of goods for goods. Such an economy is called C-C economy i.e., commodity for commodity exchange economy. In such an economy, the trading costs are
1) search cost
2) cost of waiting i.e., disutility of waiting
Drawbacks of barter system
1) Lack of double coincidence of wants: The simultaneous fulfillment of mutual wants by buyers and sellers is known as double coincidence of wants. Barter system requires double coincidence of wants. If A possesses a cow and wants exchange it for a horse, he has to find a person who cannot only spare a horse but also wants a cow.
2) Lack of common measure of value: It relates to the absence of a common unit in terms of which estimate the value the goods and services. In what proportion the goods are to be exchanged depends upon the necessities of the two parties in which case one party may be bound to suffer. This problem is aggravated if the commodity concerned is indivisible.
3) Lack of standard of deferred payments: Barter system lacks any satisfactory unit to engage in contracts that involve future payments. In a barter economy, future payments would have to be stated in terms of goods or services. This could lead to the following problems: a) there could be disagreement regarding which specific commodity would be used for repayments. b) there could be disagreement regarding quality of goods or services to be repaid. c) the commodity to be repaid would increase or decrease in its market value.
4) Lack of store of value: Barter system does not provide for any method of storing generalized purchasing power. People