Money is a crucial element in any economy, facilitating trade, investment, and economic stability. This chapter explores the evolution of money, its types, and its functions in the economy, tailored for UPSC Prelims preparation.
Evolution of Money
Money has evolved over time to meet the needs of trade and economic systems, progressing through distinct stages.
Barter System: Goods and services were exchanged directly, limited by the double coincidence of wants.
Commodity Money: Items like grains, cattle, or metals (gold, silver) served as money, valued for their intrinsic worth.
Metallic Money: Standardized coins made of gold, silver, or copper, used in ancient India (e.g., Punch-marked coins).
Paper Money: Introduced as representative money, backed by gold or silver reserves (e.g., British India’s paper currency).
Fiat Money: Modern currency with no intrinsic value, accepted as legal tender by government decree (e.g., Indian Rupee).
Digital Money: Includes electronic payments, mobile apps (UPI), and cryptocurrencies like Bitcoin (not legal tender in India).
Example: In 2016, India’s demonetization replaced ₹500 and ₹1,000 notes with new fiat currency to curb black money, showcasing the shift to modern money.
Types of Money
Money is classified based on its form, function, and usage in the economy.
Legal Tender Money: Currency mandated by law (e.g., ₹10, ₹20, ₹100 notes and coins issued by RBI).
Near Money: Assets easily convertible to cash, like fixed deposits or treasury bills.
Commodity Money: Items with intrinsic value (e.g., gold, historically used in trade).
Fiat Money: Currency without intrinsic value, backed by government trust (e.g., Indian Rupee).
Digital Money: Electronic forms like UPI transactions, which accounted for 80% of India’s retail payments by volume in 2024.
Cryptocurrency: Decentralized digital currency (e.g., Bitcoin), not recognized as legal tender in India as of 2025.
Example: The RBI’s Digital Rupee (e-CBDC), launched in 2022, is a digital form of legal tender, piloted for retail and wholesale transactions.
Functions of Money
Money serves multiple roles in facilitating economic activities, as outlined below.
Primary Functions
Medium of Exchange: Eliminates the barter system’s limitations by enabling trade (e.g., buying goods with rupees).
Measure of Value: Acts as a common unit to express prices (e.g., a book priced at ₹500).
Secondary Functions
Store of Value: Allows wealth to be saved for future use (e.g., savings in a bank account).
Standard of Deferred Payments: Facilitates loans and credit transactions repayable over time (e.g., EMIs for a car loan).
Unit of Account: Simplifies accounting by measuring economic transactions in a standard unit (e.g., GDP in rupees).
Contingent Functions
Basis of Credit: Enables lending and borrowing in the financial system.
Distribution of Income: Allocates national income among factors of production (e.g., wages, rent).
Measure of Wealth: Quantifies assets and liabilities (e.g., net worth in rupees).
Example: UPI transactions, handling ₹20.64 lakh crore in March 2024, demonstrate money’s role as a medium of exchange in digital payments.
Key Concepts for Prelims
Understanding related terms is essential for UPSC Prelims.
Money Supply (M3): Includes currency, demand deposits, and time deposits, measured by RBI. In 2024, M3 grew by ~10% annually.
Legal Tender: Currency that must be accepted for transactions, as per RBI Act, 1934.
Demonetization: Withdrawal of currency’s legal tender status (e.g., 2016 demonetization of ₹500 and ₹1,000 notes).
Central Bank Digital Currency (CBDC): RBI’s Digital Rupee, launched in 2022, to enhance digital transactions.
Key Points for Prelims
Money eliminates the barter system’s double coincidence of wants.
RBI issues currency under Section 22 of the RBI Act, 1934.
India’s currency is fiat money, backed by government trust, not gold.
UPI, launched in 2016 by NPCI, revolutionized digital payments in India.
Cryptocurrencies are not legal tender in India as of 2025.
Summary of Money & Its Functions
Aspect
Description
Examples
Evolution
Barter to digital money
Punch-marked coins, Digital Rupee
Types
Legal tender, fiat, digital
₹100 note, UPI, CBDC
Functions
Medium of exchange, store of value
UPI payments, bank savings
Frequently Asked Questions (FAQs)
Q1: How does money solve the problems of the barter system?
Ans: Money eliminates the double coincidence of wants by acting as a medium of exchange, accepted universally for goods and services.
Q2: What is the difference between fiat money and commodity money?
Ans: Fiat money has no intrinsic value and is backed by government trust (e.g., Indian Rupee), while commodity money has intrinsic value (e.g., gold coins).
Q3: Why is the Digital Rupee significant?
Ans: The Digital Rupee, a CBDC, enhances transaction efficiency, reduces costs, and strengthens RBI’s control over money supply.