Money and Banking 1

Barter trade

This is a form of trade where goods and services are exchanged for other goods and services.

Benefits

1. Satisfaction of wants: And individual is able to get what he or she needs.

2. Surplus disposal: an individual or country is able to dispose off its surpluses.

3. Social relations: it promotes social links since the communities trade together.

4. Specialization: some communities shall specialize in a particular commodity.

5. Improved living standards: this is enhanced by receiving what one is unable to produce.

Limitations of Barter trade

(i) Lack of double coincidence of wants:

- it is difficult to find two people with the need for each other’s product at the same time.

(ii) Lack of store of value/ perishability of some commodities:

- some goods are perishable thus their value cannot be stored for a long time for future purposes e.g. one cannot store vegetables for exchange purposes in future.

(iii) Indivisibility of some commodities:

- it is difficult to divide some products like livestock into smaller units to be exchanged with other commodities.

(iv) Lack of standard measure of value:

- It is not easy to determine how much one commodity can be exchanged for a given quantity of another commodity.

(v) Transportation problem:

It is difficult to transport bulky goods
especially when there is no faster means of transport.

(vi) Lack of a standard deferred payment:

- The exchange of goods cannot be postponed since by the time the payment is made, there could be fluctuation in value, demand for a commodity may not exist and the nature and quality of a good may not be guaranteed.

It may be therefore difficult what to decide what to accept for future payment.

(vii) Lack of specialization:

- Everyone strives to produce all the goods he
or she needs due to the problem of double coincidence of wants.

(viii) Lacks unit of account

- It is difficult to assess the value of commodities and keep their record.

Money System

Money is anything that is generally accepted and used as a medium of exchange for goods and services.

Features/ characteristics of Money

For anything to serve as money, it must have the following characteristics:

Acceptability: The item must be acceptable to everyone.

Durability: The material used to make money must be able to last long without getting torn, defaced or losing its shape or texture.

Divisibility: Money should be easily divisible into smaller units (denominations) but still maintains it value.

Cognizability: The material used to make money should be easily recognized. This helps reduce chances of forgery.

It also helps people to differentiate between various denominations.

Homogeneity: Money should be made using a similar material so as to appear identical.

This eliminates any risk of confusion and forgeries.

Portability: Money should be easy to carry regardless of its value.

Stability in value: The value of money should remain fairly stable over a given time period.

Liquidity: It should be easily convertible to other forms of wealth (assets).

Scarcity: It should be limited in supply. If it is abundantly available its value will reduce.

Malleability The material used to make money should be easy to cast into various shapes.

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Not easy to foreign money should not be easy to imitate.

Functions of Money

(i) Medium of exchange:

It is generally acceptable by everyone in exchange of goods and services. It thus eliminates the need for double coincidence of wants.

(ii) Store of value:

It is used to keep value of assets e.g. surplus goods can be sold and then money kept for future transactions.

(iii) Measure of value:

Value of goods and services are expressed in money form. Performance of businesses is measured in terms of money.

(iv) Unit of account:

It is a unit by which the value of goods and services are calculated and records kept.

(v) Standard of deferred payment:

it is used to settle credit transactions.

(vi) Transfer of immovable items (assets):

Money is used to transfer assets such as land from one person to another.

Demand for Money

This is the tendency or desire by an individual

or general public to hold onto money instead of spending it.

It also refers to as liquidity preference.

Money is held by people in various forms:

• Notes and coins

• Securities and bonds

• Demand deposits such bank current account balances.

• Time deposits such as fixed account balances

Reasons (Motives) for Holding Money

1. Transaction Motive:

Money is held with a motive of meeting daily
expenses for both the firms and individuals. The demand for money for transaction purpose by individuals depends on the following factors:

• Size/level of individual’s income: The higher the income of and individual, the more the number of transactions thus high demand for transactions.

• Interval between pay days/ receipt of money: if the interval is long, then high amount of money will be held for transaction reasons.

• Price of commodities: if the prices are high, the value of transactions will also increase thus more money balances required.

• Individuals spending habits-people who spend a lot of money on luxuries will hold more money than those who only spend money on basics.

• Availability of credit-people who have easy access to credit facilities hold little amount of money for daily transactions than those who do not have easy access to credit.

The transaction motive can further be divided to;

• Income motive i.e. holding money to spend on personal/ family needs.

• Business motive i.e. holding money to meet business recurring needs such as paying wages, postage, raw materials. Etc

2. Precautionary Motive:

Money is held in order to be used during
emergencies such as sicknesses.

The amount of money held for this motive will depend on the factors such as:

• Level of income- the higher the income the higher the amount of money held for precautionary motive.

• Family status- high class families tend to hold more money for precautionary motive than low class families.

• Age of the individual- the aged tend to hold more money for precautionary motive than the young since they have more uncertainties than the young.

• Number of dependant- the more the dependants one has, the more the money they are likely to hold for precautionary motive.

• Individual’s temperament- pessimists tend to hold more money for precautionary motives than the optimists because they normally think things will go wrong.

• Duration between incomes- those who earn money after a short time are likely to keep less money than those who earn money after a long time.

3. Speculative Motive:

Money is held to be used in acquiring those assets whose values are prone to fluctuations such as shares/ money is held anticipating fall in prices of goods and services.

This depends on the following:

• The wealth of an individual

• The rate of interest on government debt instruments

• Interest on money balances held in the bank.

• How optimistic or pessimistic a person is.

Supply of Money

This is the amount of money/ monetary items that are in circulation in the Economy at a particular period of time. They include the following;

1. Total currency i.e.

the coins and notes issued by the central bank.

2. Total demand deposits:

money held in current accounts in banks and are
therefore withdrawable on demand.

Factors influencing supply of money

• Government policies:

If there is more money in the economy, the government will put in place measures to reduce the supply such as increasing interest rates.

• Policies of commercial banks:

The more the loans offered by commercial
banks, the more the amount of money in circulation.

• Increase in national income:

increase in national income means that more
people will be liquid due to increase in economic activities.

• Increase in foreign exchange:

The foreign exchange reserves will increase
thus supply increases.

Banking

This is the process by which banks accept deposit from the public for safe keeping and lending out the deposits in form of loans.

A bank is a financial institution that accepts money deposits from the public for safe keeping and lending out in terms of loans.

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