by The term value of money implies the number of goods and services which a unit of money can buy. According to Prof. Robertson, “By the term value of money we mean the amount of thing in general which will be given in exchange for a unit of money.”
The larger the amount of goods and services money can buy, the greater is the purchasing power of money, or its value. The value of money, therefore, depends upon the prices of goods and services. The higher the prices the smaller the purchases of goods and services; the lower the prices the higher the purchases of goods and services. The value of money (or its purchasing power) is the opposite of the price level.
According to Prof. Irving Fisher, value of money refers to the purchasing power of money. “The purchasing power of money is the reciprocal of the level of prices so that the study of the purchasing power of money is identical with the study of price level.” Judged in this way, prices of goods indicate the value of money, which stands in inverse relationship to the general price level.
Thus, the conception of the value of money is relative as it always expresses the relationship of a given unit of money and the amount of goods and services that can be exchanged for it. Some economists, however, reject the relative concept of the value of money and favour an absolute concept of the value of money.
According to Prof. B.M. Anderson, the value of money depends upon the commodity value of money upon the material used for money. Thus, the value of money lies not in its direct want satisfying power, but in its buying capacity. “Money as such has no utility except what is derived from its exchange value, that is to say, from the utility of the things which it can buy.”
Prof. G. Crowther expressed the view that the term value of money does not make definite sense as there are many values of money depending upon the uses to which it may be put. Any exact definition of the value of money, according to him, is somewhat a complicated affair. He says, “The wholesale value of money is the value of money to a person who happens to be concerned only with those commodities that are traded in wholesale on a public market. The retail value of money is its value to a family that happens to buy exactly those things which it has been established by enquiry that the average family does buy. And the labour value of money is its value to a man or a business firm that wants to hire every variety of labour.” On arbitrary assumptions Crowther feels that we can have three different values of money, no doubt, these will be arbitrary but “where there is such infinite variation, some degree of arbitrariness is necessary.”
It may, however, be understood that the value of money differs from the value of other things in one fundamental respect, namely the fact that the value of money indicates general purchasing power over goods and services. It implies that a change in the value of money affects our general ability to get goods and services in exchange. There are some economists who have rejected the concept of the general value of money and called it a mere abstraction.
Von Hayek said, “When we investigate into all influences of money on individual prices, quite irrespective of whether they are or not accompanied by a change of the price level, it is not long before we begin to realise the superfluity of the concept of the general value of money conceived as the reverse of some price level.”
The value of money, however, does not remain constant over time, it rises and falls. Changes in the value of money affect not only individual owners of the units of money but also the entire economy. Moreover, variations in the value of money inject an element of instability into the economy as a whole. It is on account of these reasons that the investigation of the factors which govern the value of money becomes of great theoretical and practical importance. We must, therefore, admit that the absolute value of money cannot be measured. But we are interested in the measurement of changes in the value of money over a period of time, rather than in its absolute value.
As Crowther has aptly put it, “What needs to be measured is not so much the value of money itself as changes in the value of money.” The value of money does not remain stable over time. It rises and falls and is inversely related to the changes in price level. A rise in the price level implies a fall in its value and vice versa. Changes in the value of money have far-reaching effects on different sections of the community. One of the oldest explanations of the determination of the value of money is the quantity theory of money. It says that the value of money depends upon the quantity of money and will fluctuate whenever the quantity of money changes.
According to this theory, money is treated like a commodity and the value of money is determined like the value of any other commodity by the forces of demand for and supply of money. According to Prof. Robertson, “Once more we can keep on the right lines if we start by remembering that money is only one of many economic things. Its value, therefore, is primarily determined by exactly the same two factors as determine the value of any other things, namely, the conditions of demand for it, and the quantity of it available.”
However, money is characterized by certain features not found in other commodities, for example, money is a means whereas other commodities, are an end, changes in the demand for and supply of money effect the general price level, whereas changes in the demand for and supply of a commodity affect the price of that commodity only and not the general price level.
On the basis of the law of supply and demand, it can be generalized that an increase in the demand for money (supply remaining unchanged), will lead to a rise in its value, i.e., to a fall in the general price level, and vice versa. Moreover, the velocity of money affects the total supply of money. It is on account of these reasons that the oldest explanation of the changes in the value of money (depending upon its demand and supply) has to be considerably modified before it can be adopted as a successful explanation of the factors determining the value of money.
The average level of all prices in a country is called the price level. There are thousands of waves in a sea, each wave having a different height.
Nevertheless, we can calculate the average level of the sea and call it the sea- level. Similarly, we can calculate the price level, although there are thousands of prices, all moving in different ways.
When the price level rises money can buy less goods and services. So we say that its purchasing power has fallen. Conversely, when the price level falls, money can buy more and we can say it purchasing power has gone up. Thus, the value of money changes inversely with the price level. In our country, the price level increased by about 400% during World War n (1939-1945). The value of the rupee fell by the same percentage.
Changes in the price level are caused by two factors:
(a) changes in the supply of money, and
(b) changes in the supply of goods and services.
When the quantity of money in circulation in a country is increased (e.g., by printing new notes) more money is available to the people for making purchases, the demand for goods and services goes up and the price level tends to rise.
Conversely, if the supply of money decreases people can buy less and the price level tends to go down. Again, if there is an increase in the supply of goods and services, the price level tends to fall and, in the converse case, it tends to rise.
Thus, if the supply of money increases by 25% and the supply of goods and services also increases by the same 25%, there will ordinarily be no effect on the price level. There are other factors which influence the price level (e.g., the number of times money changes hands or the velocity of circulation) but the first two factors are the most important of all.
In India, during World War II, there was a large increase in the volume of notes printed by the Government. There was, at the same time, a decrease in the supply of goods (due to reduction of imports, etc.). Consequently, the price level increased many times.
It is possible to analyse the causes of price changes in a different way. Modern writers believe that price level changes are brought about by changes in the level of income, i.e., the average amount of money earned by that people when more income is earned, the demand for the goods and services goes up and price rise. When income falls, less goods and services are demanded and price fall. [Changes in the level of income depend on two factors, the volume of savings and the volume of investment in the country.
The Inflation Machine:
When inflation is reduced to its simplest elements, its proximate causes can easily be identified.
Then prices will remain unchanged. Of course, prices of individual items will fluctuate due to changes in demand and supply conditions, but the aggregate price level will be stable. In fact, the inflation machine is nothing more than or less than a broad view of supply and demand and the market clearing price.
Now, if we load the left-hand side of the inflation machine with more money than the value of goods and services on the right side, prices will surely increase. Competition for the limited amount of goods that is available will rare prices. Another way to load the left-hand side of the inflation machine is for the same number of rupees to be spent with greater frequency. This is called increasing the velocity of money.
The rupees flow through the economic system faster and this creates a similar effect. Alternatively, if people take money out of savings and spend it, that increases the number of rupees in competition for the available goods. The effect is the same competition for what is available on the right side will drive prices up.
Measurement of Changes in the Value of Money:
Changes in prices are not uniform. Some prices rise, others fall; while still others remain stationary. They are like bees dashing out of a hive higgledy-higgledy, some buzzing off this way, some that way, while others keep hovering at the spot. But there may be a trend in a particular direction. A comparison of price changes would give a very confusing picture. We have to discover the extent of the overall changes in the value of money before suggesting a remedy. The seriousness of the disease must be known before a remedy can be suggested.
Index Numbers:
The device of index numbers comes to our aid in measuring changes in the value of money or price level. An index number is a statement in the form of a table which represents a change in the general price level. Index numbers have great importance in these days. When it is desired to find out to what extent prices have risen or fallen, an index number is prepared. In every advanced country, index numbers are being regularly prepared officially by the governments and also non-officially by other bodies interested in economic changes.
Preparation of Index Numbers:
The following steps are necessary for the preparation of index numbers:
(a) Selection of the Base Year:
The first thing necessary is to select a base year. It is the year with which we wish to compare the present prices, in order to see how much the prices have risen or fallen. The base year must be a normal year. It should not be a year of famine, or war, or a year of exceptional prosperity.
(b) Selection of Commodities:
The next step is to select the commodities to be included in the index number. The commodities will depend on the purpose for which the index number is prepared. Suppose we want to know how a particular class of people has been affected by a change in the general price level. In that case, we should include only those commodities which enter into the consumption of that class.
(c) Collection of Prices:
After commodities have been selected, their prices have to be ascertained. Retail prices are the best for the purpose, because it is at the retail prices that a commodity is actually consumed. But retail prices differ almost from shop to shop, and there is no proper record of them. Hence we have to take the wholesale prices of which there is a proper record.
(d) Finding Percentage Change:
The next step is to represent the present prices as the percentages of the base year prices. The base year price is equated to 100, and then the current year’s price is represented accordingly. This will be clear from the index number given on the next page.
(e) Averaging.
Finally, we take the average of both the base year and the current year figures in order to find out the overall change. In May 1985, the price index was 355 which means that the price on the average were more than three-and a-half times as much or 255 per cent higher than what they were in 1970-71.
