A Detailed Theory on Money in Economics 2023

Table of Contents


Here, we will understand that how Money in economics has helped a lot in Creating India Financially stable since Independence. The Money played a very important role in the History of Indian Economy. The amount of money is kept in Banks as reserves to fulfil the requirements of public by lending them loans.  In this article, we will learn about functions of Money, how our economy growth depends on it, types of money, money supply system, methods to measure, demonetization, and some most important terms in detail.

Definition of Money in economics

The definition of Money is, money is a universally accepted medium of exchange due to its liquidity form. By which any person can buy or sell products into the market. Money transactions can be done in the form of cash, coins, cheques, demand drafts, ATM card swipes, etc. We can also repay loans through money. With the help of money people can trade very easily. But sometimes transactions are made without the use of money and that system is known as Barter system. In rural areas people do not have enough to pay for goods and services in the form of money. Then they use wheat, rice, etc. these another form of transactions instead of money to pay their goods and services purchasing value.

Functions / Importance of Money

  • Widely used medium of exchange
  • It fulfils our needs time to time
  • Readily acceptable form
  • Better fungibility and divisibility
  • Higher durability
  • It helps in our economy growth
  • Liquidity
  • Can be used for settlement of debts
  • Can be kept in fixed deposit accounts in banks
  • Easily transferrable

Types of Money

  1. Commodity money
  2. Metallic money
  3. Paper money
  4. Bank money
  5. Barter system
  6. Crypto currency / Bit coin
  7. Plastic money


  1. Commodity money: – It is that money whose value is countable in commodity sector like gold, silver.
  2. Metallic money: – It is money which is made up of pure silver and gold metals like coins. The Metallic money is also known as Token Money.
  3. Paper money: – This money is made up of paper notes and these notes are issued by RBI (Reserve Bank of India). Like currency notes.
  4.  Bank money: – All online transactions come under Bank money system. It saves greater time over long distances transactions. A large amount of money can be easily transferred in just a couple of minutes. Like cheques, NEFT, RTGS, Demand Drafts.
  5. Barter system: – In this system, we can exchange goods and services in the form of other goods and services. Money is not included under this system. Like wheat, rice exchanges with other form of goods and services. Mostly this type of system is used in rural areas.
  6. Crypto currency / Bit coin: – It is an electronic form of money and unregulated digital currency. It is not controlled by Banking Authorities. It is just transferred over internet and stored into software applications.  
  7. Plastic money: – Credit cards and debit cards come under plastic money system.

Note: – Currency notes and coins are called Fiat money. These are issued in the market by the Government orders. They are not rejected by any person of the country and they are commonly accepted medium of exchange.

Value of Money

It means the buying power of money i.e.  buying power of money is that power by which we can purchase goods and services in exchange by currency notes.

Demand for Money

Due to the Liquidity form of money, it is widely acceptable and easily exchangeable. People can earn interest on their savings by depositing money in Banks fixed deposits. The demand for money has also increased due to the online transactions.

Determinants of Money

  • Inflation minimizes demand of money
  • Net National income made by firms after measuring
  • Higher disposable income lets us to spend more
  • Higher interest rates also decrease demand for money

Currency deposit ratio (CDR)

It is the ratio of money held by public in currency to that of their holdings in fixed deposits in banks.

Reserve deposit ratio (RDR)

It is the portion of total deposits kept as reserves by the commercial banks.

Merchant Discount Rate (MDR)

  • It is a cost paid by merchants to bank for accepting online payments in digital form through their customers.
  • It is also known as Transaction Discount Rate
  • A percentage of transaction amount is charged by banks.

High Power Money

It is the whole liability of Reserve Bank of India. It is consisted of paper money, token money and deposits.

This liability must be supported through equal value of assets. The origin of high-power money supply is RBI and Government of India.

  • RBI issues currency notes in the denomination of 2 ,5, 10, 50, 100, 200, 500 which is called as Reserve Money.
  • Smaller denominations like 1rupee coins and notes are issued by RBI in the name of Government of India.

Minimum reserve system by RBI: –

The RBI is required to keep near about Rs 200 crore as reserves with itself.

Money Supply

The Supply of Money is a total reserve of money which in flow among the public in a specific period of time. The supply of money is the product of Money multiplier and reserve money.

The money supply system was first introduced by RBI in April 1977. The money supply can be measured with the help of following methods: –

  • M0 – Reserve money
  • M1 – Narrow money
  • M2 – Narrow money
  • M3 – Broad money
  • M4 – Broad money

Explanations of Reserve, Narrow and Broad Money (M0, M1, M2, M3, M4)

  • M0 = Currency in circulation + Banker deposit with RBI + Other deposit with RBI
  • M1 = Currency with Public + Demand Deposits with the Banks + other deposits
  • M2 = M1 + Post office savings
  • M3 = M1 + public time deposit with banks
  • M4 = M3 + all fixed deposits with post office but not includes National Savings Certificate

Money Supply gets affected by following reasons

  • Monetary policy
  • Fiscal policy
  • When public makes interest in keeping their savings in bank fixed deposits rather than holding in hand.
  • High tax system
  • In economy booming time money supply increases but in depression time money supply decreases.

Determinants of money supply

  • Higher reserve ratios decrease the availability of money in the market.
  • Higher bank reserves also decrease the availability of money
  • Maximum bank deposits shorten the supply of money
  • Higher interest rate reduces the customer interest to borrow loans through bank which indirectly minimize the supply of money into the market.

Credit Creation

A credit creation is a situation when banks offer more loans to its customers. Banks keep some amount of money as reserve money as per RBI rules and the extra amount of money is further used in the form of loans distributing. The amount of money left after giving the loans is called credit multiplier.

There are two types of deposits in the bank: –

  • Primary deposit: – it is the amount of money deposited by people in banks as a fixed deposit.
  • Secondary deposit: – The sum of primary deposits into bank is further used by banks to lend loan to the borrower into the market.

Types of credit creation

Credit creation is done on the basis of need in market. This is a system of demand and supply where customers demand for money and the bank supply money in the form of loans. Here different types of loans mentioned below: –

  • Commercial loan
  • Personal loan
  • Instalment credit
  • Operating credit

Advantages and Disadvantages of Credit Creation

Advantages of credit creationDisadvantages of credit creation
Banks become confidential medium where people can do fixed deposits and the borrower can take loans legally.Lending loan to customers is totally based upon surplus amount only. Banks do not use reserve cash to provide loans to its customers.
Always loan offered by the bank is the surplus amount left after keeping some cash as reserve in bank.During recession time there is a fall in demands of loans.

Types of currencies into the market (Hard, Soft, Hot, Helicopter)

Hard currency

  • Highly recommended international currency
  • It is the biggest currency in the world economy
  • High liquidity
  • Best diversified system

Soft currency

  • The easy availability of currency in its market like Indian rupee

Hot currency

  • A name given to hard currency for a short period of time

Helicopter currency

  • To enhance uses during recession time, this money is distributed by the central bank of country at free of cost

Indian Currency detailed information

  • In India the first paper currency issued was Rs 1 note during British East India Company
  • This note was issued by two banks namely- Bank of Hindustan and presidency bank
  • According to the RBI act 1934, section-22, only RBI has the power of issuing bank notes of any denominations except Rs 1 note.
  • Rs 1 note currency is issued by Finance ministry with the Finance Secretary signature.
  • RBI is the currency controller of India
  • RBI can issue notes of any denominations up to Rs 10,000
  • On every currency note, the signature of RBI Governor is mandatory
  • The coins are distributed into the market by RBI on behalf of Indian Government. As coins are minted by Government of India
  • The first note printing press opened in 1928 at Nasik (Maharashtra) – Note press (CNP)
  • 17 different languages are used in mention amount of a note


  • It is an internet -based mode of exchange
  • It is not controlled by any Central Authority
  • It was created in 2009 by Satoshi Nakamoto


  • It is a digital currency and no any Central Authority is controlling it.
  • The system designed in such a way that the online system network maintains a record of each transaction done without knowing the identities of both parties i.e.  sender and receiver.
  • With the help of computational power, Bitcoins are mined
  • Bitcoin is not printed on the paper notes
  • It is a part of a blockchain system

Monetary Policy & its Advantages

  • To control the money supply in the economy, policies are made and those policies are called Monetary Policies.
  • In every two months RBI revise its monetary policy
  • Repo Rate, Reverse Repo Rate, SLR, CRR, Bank Rate, etc. all activities are controlled and revised by RBI, India.

Advantages of Monetary Policy

  • To keep stability in finance sector
  • To fulfil the requirements of credit
  • To beat the inflation

Digital Payments Systems in India

To make India ‘cash-less’, RBI took various steps in the payment transactions. It has removed various charges levied on NEFT and RTGS transactions. People now can send a huge of money without any charges.  

Platforms for digital payments

UPI: -Unified Payment Interface

  • Unified payment interface was first introduced in April 2016.
  • It allows user to send money from one bank account to another bank account with the help of smart phones.
  • It does not include any transaction charges
  • It is easy to use
  • Time saving online transaction process
  • A transactional limit of up to Rs 1 lakh daily

BHIM: – Bharat Interface for Money

  • It is a mobile based NPCI’s (National Payment Corporation of India) UPI application
  • It was launched in dec2016 by NPCI
  • BHIM 2.0 version has been launched in the market and a person can send money up to Rs 1 lakh only after completing the k Y C (know your customer) process
  • It is a secured type system


  • It is a person to merchant mobile payment system
  • QR code is consist of so many small black colour squares arranged in a single square grid on a white background colour

Types of ATM in India

Issued by Banks

  • These are owned and circulated by Banks
  • Each ATM card carries a Bank LOGO
  • Ru Pay was the first domestic Debit and Credit ATM card introduced in India.

Brown label ATM Card

  • These are owned by a none banking firm or we can say third party

White label ATM Card

  • They do not carry any logo of banks
  • These are operated by none bank entity
  • Customers have to pay fees for money withdrawal


  • Demonetization is used to -strengthening the currency, beat inflation, tackle the corruption in system, to get to know the Black Money circulating in the market


Demonetization meaning in Hindi – विमुद्रीकरण

Positive & Negative points of Demonetization

Positive points of Demonetization

  • Traced Black Money
  • Increased tax collection value
  • Had Greater impact to stop financing for terrorism
  • Increased digital transactions in large amount

Negative points of Demonetization

  • Poor planning was there as it was notified suddenly
  • Worst impact on private jobs
  • Expenditure of Government also increased during demonetization.
  • Banking sector had disturbed to avail the loans to businesses or individuals

Demonetization date in India

  • The first Demonetization in India was initiated in 1946
  • RBI demonetized notes of Rs 1,000 and Rs 10,000 in 1946
  • In November 2016 Government of India again Demonetized currency notes of Rs 500 and Rs 1000.
  • New currency notes of Rs 500 and Rs 2000 were launched after November 2016  

Black money

An income which is not mentioned by any person, firm in a nation is known as Black Money.


The money earned by any person or an entity with illegal form is also called Black Money.

Black Money is always kept hidden in National Income and never showed in Indian GDP whereas

White Money is that money which is earned by a person in legal form and mentioned into the Income Tax Return File (ITR).

Origin of Black Money

  • Crime
  • Corruption
  • Money laundering
  • Smuggling

Black Money spreading due to following reasons

  • Traders who do not provide bill receipts on selling goods and services
  • People have a lot of money in real estate sector and they show their property undervalue
  • People buy commodity products to hide their original wealth
  • People earns a lot of interest on their money by giving it to other people

How Black Money affects our Indian Economy

  • It affects credibility
  • Black money used for doing illegal works
  • It creates a hidden economy parallel to our original economy
  • Black money also increases value of underperform assets. Due to which asset bubble can burst any time
  • Indian Government incurs a huge amount of loss every year due to this Black Money system.

Steps taken against Black Money: –

  • Demonetization system
  • Digital / online transactions of money
  • Linking pan card to Aadhar card to file ITR tax

Some Legal Actions taken by Indian Government

  • Benami Transactions Prohibition act in 1988
  • Prevention of Money Laundering act in 2002
  • Lokpal and Loka-yukata act in2013
  • The Undisclosed Foreign Income and Assets Bill in2015

Money Laundering system in India

  • It is a system in which the Black money is totally converted into the White money
  • People spend black money in purchasing goods and services
  • People use their money as tax haven and again use it further to invest back to their country by showing White Money


In Indian Economy there are so many parts associated with Money which tells us how money is being created, how it is used in several types of systems. Money shows a true image of economic and technical growth in Indian History. India has created a balanced digital online platform.

With a consistent performance, India can achieve a bright future for its currency and people living in country.


  1. What do you mean by “Merchant Discount Rate” ?

    Answer – The charge levied to a merchant by a bank for accepting payments from his customers through the bank’s debit cards.

  2. When supply of money remains same when there is an increase in demand for money?

    Answer – When there is a decrease in rate of interest

  3. Which factors would result in an increase in the money supply in the economy?

    Answer – Purchasing of Government-Securities from the public by the Central Bank and Borrowing by the government from the Central Bank.

  4. What a Bank Rate increase generally indicates?

    Answer – Central Bank is following a tight money policy.

  5. With reference to ‘Bitcoins’ sometimes seen in the news, how is it transacted?

    Answer – Online payments can be sent without either side knowing the identity of the other.

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