SECTION 5: THE FINANCIAL SECTOR

SUBTOPIC: MONEY

Define the financial Sector:

The financial sector is a section of the economy made up of firms and institutions that
provide financial services to individuals, the government, and firms. This sector is comprised
of banks, investment companies, insurance companies, development banks, stock
exchanges, credit unions etc.
The financial sector generates a large portion of revenue for the economy. Economists tend
to tie the health of the economy, largely to the strength of its financial sector. The stronger
it is, the healthier the economy. A weak financial sector typically means the economy is
weakening.
Before we delve deeper into the financial sector, its role etc. Let us examine the history of
money, its definition, features, functions, demand money, money supply and more.
History of Money
In Early economies long before money was used, trade and exchange took place through
barter. The scarcity problem was solved under the Subsistence economy (direct production )
which included hunting, gathering, fishing, making tools and weapons out of stone or wood
etc. As the economy developed, division of labour emerged and people began maximizing
their individual skills, by splitting tasks, consequently people began to concentrate on one
task (specialization). Eventually the societies moved away from direct production to indirect
production where man began to produce to satisfy the wants of others in society.
In the simple economy when man could not satisfy all their needs and wants they began to
exchange their surplus (excess) goods. This first form of trade was known as bartering.
Barter is the direct exchange of goods and services for other goods and services. For
example, One farmer might trade his excess fruits for chicken from another who rears
chicken. Therefore, these individuals were able to trade, and they both enjoyed a greater
variety of goods. If the barter was successful it meant, the two parties wanted what each
other had (see picture below).
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What if the parties above did not want what each other were trading? This would pose
some difficulties. Hence, barter was the first form of trade, but it had several challenges as
indicated below:
1. Double coincidence of wants: Exchange can only take place if each party wants what the
other has to offer for example, if you have eggs to sell, and I have economics lessons to
offer, this would be no good if I do not wish to swap economic lessons for eggs. There is no
double coincidence of wants.
2. Unequal exchange: It is difficult to fix rates of exchange acceptable to each party for
example, a problem could arise in deciding how many eggs would be given for an
economics lesson.
3. Some goods are not divisible: The exchange of large commodities for smaller ones is
difficult. If we were exchanging a chicken for a table, is the chicken worth a whole table or a
piece of a table?
4. Some goods were bulky and difficult to transport
5. Impossibility of saving (store of value): Some products such as meat and vegetables, are
perishable and can be difficult or may be impossible to store.
To solve the problems associated with barter money was developed. (refer to diagram,
below).
How do we define money?
Money is defined as anything that is commonly accepted as an instrument or medium of
exchange. It is used to settle debts and pay for goods and services.
Commodity Money
In the past many items were used as money such as beads, cattle, cigarettes in World War II,
gold, iron, and silver, these were called commodity money. These monies were known to
have intrinsic value.
Fiat Money
Nowadays, we use fiat money, these are items which serve as money because of the value
given to it by law but have no intrinsic value. A paper $1000 JMD has no value in and of
itself except through the order of the government which makes it so.
In earlier times, gold and other precious metal were used to back notes and coins. People
store their gold with goldsmiths who acted as bankers. Each time a trader wanted to buy
goods he would visit the goldsmith. Since the gold and metals were difficult to carry around
goldsmiths began to print banknotes in smaller denominations e.g. $1, $2 notes or give
IOU’s. At this time, all bank notes were fully convertible to gold. Thus, the trader would
purchase goods and services and the seller accepted the notes. The seller would now have a
claim to gold with the goldsmith, equal to the value of all the notes received. This was the
origin of paper currency.
As the economy expanded gold and silver became limited in supply and increasingly scarce.
Bankers began issuing loans since depositors were only drawing a small amount of gold.
More loans allowed for more circulation of gold and it fostered greater economic activity.
Unfortunately, it also meant that the number of banknotes issued exceeded the amount of
gold that was stored. Therefore, to maintain financial stability and acceptability in the
financial system, the government (via the central bank) took control of issuing money. (we
will discuss further in upcoming lessons).
Money in the form of notes and coins are no longer convertible to gold. Economic necessity
has led to the creation of a legal tender, this is where money has buying power (fiat money)
because the government has declared that it must be accepted in the settlement of debts.
Near Money
The world today is fast paced, and transactions are conducted electronically and globally.
Hence, the need for money in the form of notes and coins has declined. Consumers and
businesses have moved to more convenient methods of payment such as cheques,
credit/debit cards, electronic transfers, postal orders, money orders, bank drafts, bills of
exchange to carry out business. These modern forms of payment are considered near
money. Near money satisfies the need for a medium of exchange but it is not a legal tender.
Consequently, businesses do not have to accept these forms of payment; they can
demand cash if so desired.
Characteristics of money
To be a good medium of exchange money must have the following features:
✔ It must be acceptable
✔ It must be relatively scarce
✔ It must be a legal tender. However, small denominations of coins are not legal
tenders for large debts. Also, a cheque is not a legal tender.
✔ It must be homogeneous
✔ it must be portable
✔ It must be divisible
✔ it must be durable

Functions of Money
1. A medium of exchange: It is acceptable as a means of payment for goods and
services, which eliminates the problem of requiring a double coincidence of wants.

2. Store of value: Unlike some goods money can be stored or save for use at a later
date. It gives the saver purchasing power in the future, eliminating some of the issues of
difficulty in saving under the barter system.

3. A unit of Account: This means that money is a measure of value. All goods and services
can be given a price. It is also used for economic calculations and makes accounting simpler.
This function helps to solve the problem of unequal exchange in barter as prices are quoted
in terms of money.

4. A means/standard of deferred payment: Money makes credit transactions possible, since

goods can be paid for some time in the future. Therefore, capital can be borrowed for
businesses and consumers can buy on hire purchase or other forms of credit. Credit under
barter would be complex and confusing.
Your Turn:
Kindly answer the following questions for discussion in class on Wednesday.
1. Explain the concept of barter, giving an example.
2. Discuss two Disadvantages of Barter using examples.
3. Define the term ‘money’.
4. Briefly explain the terms commodity money. fiat money and near money.
5. Identify three commodities used in the past as money.
6. Describe how the introduction of money solved the problems of barter.
7. Outline five (5) characteristics of money

Research the following terms for the upcoming zoom session May 27,2020.
1. Credit cards
2.Debit cards
3. Cheques
4. Bill of Exchange
5 E-commerce
6. Demand money
6. Money Supply
7. Supply of money in terms of M0, M1, M2
8. traveller’s cheque
9. savings deposits
10. chequing deposits
10. money marketaccounts