Significance of Money

The following are some of the advantages of money which show that money plays a vital and significant
role in the modern economy:

Classical economists thought that money is a just veil and does not affect the real volume of goods and
services in the economy, that is, the level of national product. According to them, money only affects the
price level in the economy with no effect on the levels of real income and employment.

They contended that what we really want was goods and services which satisfy the wants of the people and
promote their welfare. Therefore, according to them, we must go behind the veil of money to see changes in
the total output of goods and services or in real income.

It is true that what we really want is not money but the goods and services which money can buy. It is the
goods and services which satisfy the wants of the people and not money as such. But it must not be
concluded from this that money is of no real importance.

Modern economic life based on the complex division of labour or specialization which has added so greatly
to the productivity of the economy will not be possible without money.

1. Money has Facilitated Exchange and Promoted Trade:

In the first place by serving as a medium of exchange and a common measure of value, money has removed
the difficulties of the barter system and promoted trade in the economy. The difficulties of the barter system,
namely, lack of double coincidence of wants, lack of division and lack of common measure of value are well
known. By removing these difficulties, money has greatly facilitated the process of exchange. In the absence
of money, trade and exchanges must have been few and far between and entailed a great waste of time and
energy.

2. Money Promote Division of Labour and Productivity:

Money is of great importance as it promotes division of labour and productivity in the modern economies.
Since under the barter system, exchange was difficult, a man had to be self-sufficient, that is, produced most
of the goods for himself. In the absence of money there were great difficulties in exchanging goods and
services. This worked as an obstacle to the division of labour and specialisation among various individuals
and nations.

Long ago Adam Smith clearly brought out in his now well-known book “Wealth of Nations” how the
division of labour and specialisation enhance productivity and efficiency of labour force. It is this division
of labour and specialisation that has made the use of more efficient machines and advanced technology
possible for production of goods. Indeed, it is because of the output-augmenting effect of division of labour
that Adam Smith regarded increase in the division of labour as progress in technology.

By opening up the opportunities of effecting division of labour, and through facilitating exchange and trade
of goods and services money contributes to the expansion of production. Therefore, money enables the
increase in the amount of production and variety of goods and services produced. “If a modern economy
was somehow deprived of the monetary mechanism and was driven back to a system of barter, the level of

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output would be much lower and the variety of goods and services much smaller than is enjoyed with a
money system.”

3. Money Promotes Saving:

A great significance of money is that it contributes a great deal to the increase in saving of the economy.
Money has made saving easier than in the barter system. Increase in saving leads to the increase in
investment which determines economic growth of a country.

Further, money has made easier the acts of borrowing and lending and has given birth to various financial
institutions which promote saving. Investment which is made possible by saving raises the rate of capital
formation in the economy. The higher level of output in the modern economy is mainly due to the extensive
use of capital in the production process.

4. Money helps in Maximizing Satisfaction or Profits by Consumers and Producers:

Money is of immense advantage both to the consumers and producers. To the consumers money represents a
general purchasing power. He can buy anything with money he has and at any time convenient to him. Since
the values of goods are expressed in terms of common measure i.e. money, the consumer can easily compare
the relative money prices of the goods and expected utilities from them.

A consumer can easily spend his given money income on various goods in such a way that marginal utilities
goods are proportional to their prices. With this he will be maximising his satisfaction from his given
income. Thus the existence of money helps the consumer to maximise his satisfaction by acting on the
principle of equi-marginal utility.

Money helps the producer too. The producer can easily compare the money cost and money income of the
different levels of output. He can thus easily decide about the level of output which maximises his profits by
equating marginal cost with marginal revenue (MC = MR).

He can also easily decide about the units of a factor to be employed by comparing its marginal revenue
product with the money payment he has to make to it. To maximise profits he can easily equate marginal
revenue product (MRP) of a factor with the marginal factor cost (MFC) on that factor. Moreover, the
workers engaged by a producer want goods and services to satisfy their wants.

They want food, clothing, shelter and so many other things. The producer cannot supply them all these
things easily. But what be can do is to pay them in money with which they buy the commodities they like at
their own convince and when they need them.

5. Money can help in Reviving the Economy from Recession or Depression:

According to modern economists, money may play an important role in bringing about real changes. They
point out that at times of recession or depression when there exists a lot of idle productive capacity and
unemployment of labour, expansion of money supply, say through Government’s deficit budget financed by
the creation of new money will cause aggregate expenditure or demand to shift upward. This increase in
aggregate expenditure or demand will cause output and employment in the economy to rise and thus will
help the economy to recover from recession or depression.

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Beneficial effect on output and employment of expansion in money supply can be obtained even if Central
bank of a country takes steps to expand money supply in the economy say through reduction in Cash
Reserve Ratio (CRR) and through buying securities in the open market.

These steps by the central bank aim at expansion in credit availability for the businessmen. The greater
credit availability will lead to more private investment which through multiplier process will cause income,
output and employment to rise. It follows from above that money is not neutral in its effect on real income
and employment. In fact, as seen just above it plays an important role in the determination of the level of
real economic activity.