Money refers to a common medium of exchange that is issued under the law of government and acts as a legal tender for the whole country. The functions of money can be classified into the following three categories :-
1. Primary function: The primary function of money includes money as a medium of exchange and money as a measure of value.
(a) As a medium of exchange, it refers to a function of money in which money is considered as a mode of exchanging goods. This function of money solved the main problem of barter system which was double coincidence of wants.
(b) As a measure of value, it refers to a function of money that helps in determining the value of goods and services. Money is taken as the common denominator while measuring the value of goods and services in monetary terms.
2. Secondary function: The secondary function of money includes
money as a store of value and money as a standard of deferred payment.
(a) As a store of value, it refers to the function of money that helps individuals in storing their wealth in the form of money. Therefore, money acts as an asset that sustains value over a period of time
(b) As a standard of deferred payment, it refers to one of the most important functions of money. Deferred payments refer to payments made on loans, salaries, pensions, insurance premium, interests, and rents. The necessary condition for deferred payment is that the amount of repaid money should be the same as it was at the time of purchase of the good. Since all the goods and services can be expressed in terms of money, it makes the future payments easy and functional.
3. Contingent function:
(a) Distribution of national income: Money helps in optimum distribution of national income among different factors of production by generating factor incomes like rent, interest, wage and profit.
(b) Basis of credit creation: Credit creation by commercial banks is not possible without money. Money as a store of value has encouraged savings by people in the form of demand deposits in the banks which are used by the commercial banks to create credit.
(c) Maximization of satisfaction: Money helps the consumers and producers in maximizing their satisfaction by measuring the value of everything in terms of money. A consumer derives maximum satisfaction by equating the price (expressed in terms of money) of each commodity with its marginal utility (satisfaction). Similarly, a producer maximizes his satisfaction (profit) by equating the marginal productivity of a factor with price of such factor.
(d) Increases productivity of assets: Money increases the productivity of capital as it is the most liquid asset and can be put to alternative uses. Due to liquidity of money, capital can be easily transferred from less productive uses to more productive uses.