Answer to Question #234388 in Finance for Precilla

Question #234388

Using South African practical examples, explain the functions of money and clearly distinguish 

between the M1, M2 and M3 aggregate measures for money supply


1
Expert's answer
2021-09-07T09:46:52-0400

a) functions of money 

Medium of Exchange 

 

One of the most important primary functions of money is that it acts as a medium of exchange. This means that a buyer can buy any amount of goods/services at any time by paying the seller the adequate monetary value of those goods and services.

Money as a medium of exchange has general acceptance worldwide. And hence it leads to the removal of the problem of 'double coincidence of wants' that existed in the barter system.

Measure of Value

 

The expression of exchange ratios in the common denomination was difficult in the barter system. As different goods/services have different intrinsic value. Money, by acting as a common indicator of worth, eliminates this problem. 

 Money reduces the value of goods/services to a single unit by expressing goods/services in terms of price.

It also helps in the comparison of the relative value of different goods and services, and hence is also known as 'unit of account'.

Store of value

 

Under the barter system, it was difficult to store goods for a longer period of time because most of the items are perishable in nature.

However, monetary earnings can be easily stored for future use. This implies that the purchasing power of money can be transferred from the present to the future.

Money by acting as a store of value/wealth facilitates the idea of savings that may be used to meet unforeseen events in the future. 

b)The monetary base can be defined as the total amount of currency of paper money that is in circulation in an economy in a particular time period. It is also known as M0, and this value includes all paper currency and coins in circulation, along with reserves held with the central banks of the economy.

M1 money supply includes all currency like paper money, demand deposits and traveller's cheques. M2 money refers to all components of M1 along with less liquid time deposits and money market funds. M3 money supply on the other hand calculates all the components of M1 money supply along with time deposited that are deposited with the commercial bank. 

In the South African economy, the currency is named South African rand. The M1, M2 and M3 equate all the components as discusses and all the data is updated monthly. 


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