Introduction:

• commonly accepted medium of exchange. 
• Economic exchanges without the mediation of money are referred to as barter exchanges. However, they presume the rather improbable double coincidence of wants.
• To smoothen the transaction, an intermediate good is necessary which is acceptable to both parties. Such a good is called money.

FUNCTIONS OF MONEY

• acts as a medium of exchange.
• acts as a convenient unit of account.
• A barter system has other deficiencies. It is difficult to carry forward one‟s wealth under the barter system.
• act as a store of value for individuals. Wealth can be stored in the form of money for future use.

DEMAND FOR MONEY

• Money is the most liquid of all assets in the sense that it is universally acceptable and hence can be exchanged for other commodities very easily.
• On the other hand, it has an opportunity cost. If, instead of holding on to a certain cash balance, you put the money in a fixed deposits in some bank you can earn interest on that money.

The Transaction Motive

• The principal motive for holding money is to carry out transactions.
• The number of times a unit of money changes hands during the unit period is called the velocity of circulation of money.
• We are ultimately interested in learning the relationship between the aggregate transaction demand for money of an economy and the (nominal) GDP in a given year.
• The total value of annual transactions in an economy includes transactions in all intermediate goods and services and is clearly much greater than the nominal GDP. 
• However, normally, there exists a stable, positive relationship between value of transactions and the nominal GDP.  An increase in nominal GDP implies an increase in the total value of transactions and hence a greater transaction demand for money from equation. 
• that transaction demand for money is positively related to the real income of an economy and also to its average price level.

The Speculative Motive

• An individual may hold her wealth in the form of landed property, bullion, bonds, money etc.
• For simplicity, let us club all forms of assets other than money together into a single category called „bonds‟. Typically, bonds are papers bearing the promise of a future stream of monetary returns over a certain period of time. These papers are issued by governments or firms for borrowing money from the public and they are tradable in the market. 
• Different people have different expectations regarding the future movements in the market rate of interest based on their private information regarding the economy. If you think that the market rate of interest should eventually settle down to 8 per cent per annum, then you may consider the current rate of 5 per cent too low to be sustainable over time. You expect interest rate to rise and consequently bond prices to fall. If you are a bond holder a decrease in bond price means a loss to you – similar to a loss you would suffer if the value of a property held by you suddenly depreciates in the market. Such a loss occurring from a falling bond price is called a capital loss to the bond holder. Under such circumstances, you will try to sell your bond and hold money instead. Thus speculations regarding future movements in interest rate and bond prices give rise to the speculative demand for money.
• When the interest rate is very high everyone expects it to fall in future and hence anticipates capital gains from bond-holding. Hence people convert their money into bonds. Thus, speculative demand for money is low. When interest rate comes down, more and more people expect it to rise in the future and anticipate capital loss. Thus they convert their bonds into money giving rise to a high speculative demand for money.
• Speculative demand for money is inversely related to the rate of interest.

THE SUPPLY OF MONEY

• In a modern economy money consists mainly of currency notes and coins issued by the monetary authority of the country. In India currency notes are issued by the Reserve Bank of India (RBI), which is the monetary authority in India. 
• However, coins are issued by the Government of India.
• Apart from currency notes and coins, the balance in savings, or current account deposits, held by the public in commercial banks is also considered money since chequeens drawn on these accounts are used to settle transactions. 
• Such deposits are called demand deposits as they are payable by the bank on demand from the accountholder. Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits.

Legal Definitions: Narrow and Broad Money 

• Money supply, like money demand, is a stock variable.
• The total stock of money in circulation among the public at a particular point of time is called money supply.
• RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4. They are defined as follows;

M1 = CU + DD

M2 = M1 + Savings deposits with Post Office savings banks

M3 = M1 + Net time deposits of commercial banks

M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)

• CU is currency (notes plus coins) held by the public and DD is net demand deposits held by commercial banks.
• The word „net‟ implies that only deposits of the public held by the banks are to be included in money supply. 
• The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply.
• M1 and M2 are known as narrow money. 
• M3 and M4 are known as broad money. 
• M1 is most liquid and easiest for transactions whereas M4 is least liquid of all. M3 is the most commonly used measure of money supply. 
• It is also known as aggregate monetary resources.