Money is the commonly accepted medium of exchange. Money forms the cornerstone in enabling varied economic exchanges between various parties in a modern economy.

If there is only one individual in an economy, there can be no exchange of commodities, so there is no requirement for any money. However, if there are large numbers of economic agents engaged in transactions through the market, money becomes a crucial instrument for facilitating these exchanges.

Functions of Money

•       Medium of Exchange: By overcoming the limitation of double coincidence of wants, money acts as a medium in which different commodities can be measured and exchanged
•       Unit of Account: The value of all kinds of different goods and services can be expressed in the unit of account. A unit of account is a monetary unit that can be used to value goods and services, keep track of debts, and do calculations. Money is divisible, fungible, and countable, it is used as a unit of account
•       Store of Value: Money is unbeatable, and its storage costs are also meagre. It is also acceptable to everyone at any time. In this way, money can act as a depository for individuals

Demand for Money and Supply of Money

Demand for Money

It tells us why people need money. It is determined by:

•       The value of transactions: Money is required to conduct transactions; the value of transactions determines the money people want to keep. The more significant is the number of transactions to be made, the more significant is the quantity of money demanded
•       Income Levels: Quantum of transactions depends on the income levels. An increase in income will lead to an increase in demand for money
•       Interest rates: At higher interest rates, demand for money comes down as people park their money (savings) in interest-earning bank deposits and vice-versa.

Supply of Money

In a modern economy, there are many forms of money. In a modern economy including cash, bank deposits, etc. The money supply is governed by two components that control its structure and flow. These are Currency and Demand Deposits. While Currency is an important component of a country’s money supply. The government produces two types of currency: coins and paper cash. Demand Deposits are a type of non-confidential fund offered by commercial banks. When these accounts are incorporated in a country’s economy, they are called money. 

Further, the money supply is created by two institutions: the Central Bank of the economy and the Commercial Banking System.

Central Bank

•  It is a fundamental institution in a modern economy. Majorly, every country has one central bank
• The central bank of a country oversees the amount of money in circulation to keep the economy healthy
• It also influences the money supply via influencing interest rates, creating money, and imposing bank reserve requirements
• Majorly, every country has one central bank
• To talk about India, it got its central bank in 1935. Its name is the RBI, i.e., the Reserve Bank of India
• It has several key operations. It supplies and issues the currency of the country
• It also manages the country’s money supply through various instruments like bank rates, open market operations, and variations in reserve ratios
•  It works as a banker to the government and a custodian or guardian of the economy’s foreign exchange reserves
•  It also acts as a watchdog on the country’s banking system

Commercial Banks

• They accept money from the public as a form of deposit and give loans out part of these funds to those who want to borrow
• The rate of interest paid by the banks to depositors is lower than the interest rate charged from the borrowers
• This difference between the two types, as mentioned above, of interest rates, is known as ‘spread.’ It is the profit earned by the bank
• The public prefers to keep money in banks because banks pay some interest on any deposits made. Also, it is considered safer to keep money in banks rather than at home
• Cheques and debit cards make transactions more convenient and safer, even when they do not earn any interest
• However, a bank must balance its lending activities to ensure that sufficient funds are available as CRR (cash reserve ratio) to repay any depositor on demand to maintain the depositor confidence

Conclusion

Finally, we can conclude that money is defined as anything that is widely recognized as a medium of exchange. It serves both primary and secondary purposes. Any country’s money supply is regulated by two key institutions: the central bank and commercial banks.