Question

In the old type of family household economy or "self-supporting community," which in general survived on country estates, even in Europe, until the nineteenth century, the economic processes of production and consumption can be viewed as self-contained and closed to the outside world. The self-contained aspect of the household disappeared as the various households associated with each other to exchange products, which in turn encouraged greater specialization in production. The earlier type of rural household became increasingly specialized in agricultural production and was merged into the larger economic unit. This larger unit, composed of a group of specialized economic units linked to each other through cooperation and mutual exchange, formed an exchange economy.

     "The course of economic development is often represented as if an exchange economy, with direct exchange but without money, preceded the money economy, which is then represented as if it were essentially different, and on an independent, higher plane of development. On the contrary, a more careful inquiry shows that the development of money has always been parallel to that of the exchange economy; that the exchange of goods and the use of money have mutually aided each other at every stage; and that the development of a coordinated monetary system of the modern type is approximately coincident with the effective establishment of the general exchange economy. Furthermore, there has never been an exchange economy of any degree of development -- one with an organized exchange of products between independent economic units -- without money." [Gustav Cassel, The Theory of Social Economy (New York: Harcourt, Brace; 1932), pp.47-8]

(a) Describe the characteristics of an efficient monetary system. What are the potential sources of cost reduction specific to money that could improve the efficiency of a monetary system?

(b) Explain how improvements in a monetary system would act to promote greater specialization in production, and thus, expand the volume of mutually beneficial trade. Why would improvements in a monetary system compliment and operate in parallel with improvements in an exchange economy? Carefully explain.

Answer 1

a) A monetary system may be described as the system used by a country to provide money and to control the exchange of money.It is defined as a set of policies, frameworks, and institutions by which the government creates money in an economy. Such institutions include the mint, the central bank, treasury, and other financial institutions. There are three common types of monetary systems – commodity money, commodity-based money, and fiat money. Fiat money is the most common type of monetary system in the world. For example, the Canadian Dollar is fiat money. The characteristics of an efficient monetary system are:

• It acts as the actual medium of exchange within the country
• It provides for the measure of value of goods and service
• It forms the basis of deffered payments , the ones that need to be done at a future date like promissory notes.
• It provides for a store of value , unlike barter system the value of a product can be stored under a monetary system
• A monetary system provides for easy transferability of value of goods as it is easy to detarmine exchange power.

The potential sources of cost reduction specific to money that could improve the efficiency of a monetary system are :

• Use of credit :goods are continually produced and disposed of use of credit would reduce cost of minting the money at the same time.
• Use of cards: The use of debit cards provides a systematic manner of payment to consumers but reduces the cost of minting money for the government.

b)From practical point of view , we see that all the activites be it related to consumption or production, exchange or distribution of goods , its medium of measurement today is money only.The use of monetary system has given certain precision to the economic science. Each country in the world has a monetary system of its own to carry ot its economic activities.

Improvements in a monetary system acts to promote greater specialization in production, and thus, expand the volume of mutually beneficial trade because it has removed the evils associated with the barter system like :

• Double coincidence of wants: which means that both the parties trading needed to want each others product only then trade took place in barter system
• Lack of common measure of value: Now as the biggest problem with barter was how much products needed to be exchanged between parties.
• Indivisibility of certain materials : For example a person wanted to buy rice equal to half the value of his cow which is not divisible ,so monetary system gives a common measure of value for each thing.

Improvements in a monetary system compliment and operate in parallel with improvements in an exchange economy because for exchange to take place the utmost requirement is a measure of value that is mutually accepted by all parties.The monetary system has given us money which is acceptable within the border of a country for exchange and also against foreing currencies for international exchange of goods and services. The convenience provided by monetary system improvement through money are:

• Unit of Account: Money makes things such as accounting for profit and loss of a business, balancing a budget, or valuing the total assets of a company all possible.
• Store of Value: Money acts as a medium of exchange in transactions is inherently future-oriented, it provides a means to store value obtained through current production or trade for use in the future, in the form of other goods and services.
• Standard of Deferred Payment: Money can be used to transfer value for exchange use at different times between people through the tools of credit and debt.