Question

1. Explain the characteristics of a “good” monetary system.

2. What problems exist with the use of a commodity money? Fully explain.

3. What are the advantages/disadvantages of the competing types of representative currencies?

Answer 1

1. A monetary system is a set of mechanisms through which the government provides money into the country's economy. A good monetary system has the following characteristics:

• Stability : One of the main features of a good monetary system is that it should be able to ensure internal price stability. This is a must for the economic growth of the country. Also, stable price level also solidifies the exchange rate of the country.
• Simplicity : A good monetary system must be simple and easy to apprehend. In should ensure public confidence.
• Elastic : By elasticity we mean that the monetary system should be such that it is able to increase or decrease the money supply according to the needs and requirements in the economy.
• Economical : It should not incur heavy expenditure on its operation.
• Convertibility : The currency should be able to be converted into precious metals. This ensures public confidence.
• Legal Backing : A monetary system must be backed by the law. Legal tender money ensures general acceptability.
• Flexible : A good monetary system must have built- in-flexibility. It should be capable of operating automatically without any government intervention.
• Economic Development : It must aid the government to achieve the prime objective of the economic development and welfare of the masses.

2. Commodity money is a form of money having an intrinsic value. Its value is equal to the value of the commodity itself. It can be any valuable object used as a medium of exchange. Following are the problems that exist in the use of commodity money :

• Indivisibility : Commodity money is not as divisible as traditional paper money. For example, one can convert $100 bill into two $50 or ten $10. But you can convert your cattle into a smaller denomination.
• Difficulty in assessing value : It is difficult to determine the value you are getting was as worthy as the commodity you traded.
• Quality : Another problem with commodity money is that it can vary in quality. For example, in earlier times horses were used as money to pay back debts. The people would use sick horses in it. This drove out better quality horses from the market.
• Perishable : Some commodities lose value over time. For example, if someone traded food, it would lose its value after 2 to 3 days.
• Storage costs : Unlike paper money which is feasible to carry around and store, commodity money lacks behind in both.