Fundamentals of Business Economics and Management · Money and Banking

Money: Meaning, Functions and Types of Money

Updated 10 October 2026 · Fact-checked

Money is anything generally accepted as payment for goods and services and in settlement of debts. Its primary functions are medium of exchange and measure of value. Secondary functions are standard of deferred payment, store of value and transfer of value. Types include commodity, fiat and credit money. Match each function to its label to solve MCQs.

Understand Money: Meaning, Functions and Types

Before money, people used barter: goods swapped directly for goods. Barter needs a double coincidence of wants. You must find someone who has what you want and wants what you have. It also has no common unit to price things, and it is hard to store wealth or pay later.

Money solves this. In economics, money is anything that people generally accept as a means of payment for goods and services and for settling debts. What matters is general acceptability, not what the object is made of. Shells, gold coins, rupee notes and a bank balance have all worked as money.

Money performs functions. The usual classification is: primary (medium of exchange, measure of value), secondary (standard of deferred payment, store of value, transfer of value) and contingent (uses that arise in particular situations, such as distribution of national income, liquidity base for credit and equalising marginal utility). Remember that the primary functions solve the barter problems directly. The rest build on them.

Money is also classified by what backs it. Commodity money has value in itself, such as gold or silver coins. Fiat money is declared legal tender by the government and has little value as an object. Indian rupee notes are an example. Credit money is created by bank credit and exists as deposits, cheques and similar claims. Some books also mention representative money, which is a paper claim on a commodity such as gold.

Money can also be split into legal tender and non-legal tender. Legal tender cannot be refused in settlement of a debt. Cheques and drafts are not legal tender, because a person may refuse them.

Key formulas to remember

Primary functions: Medium of exchange + Measure of value; These two directly remove the problems of barter.
Secondary functions: Standard of deferred payment + Store of value + Transfer of value; They depend on money keeping a stable value over time.
Contingent functions: Distribution of national income + Basis of credit + Liquidity (most liquid asset) + Equalising marginal utility/productivity; Wording varies by book. Learn these as extra uses beyond the five main functions.
Types by backing: Commodity money (own value) | Fiat money (government order) | Credit money (bank liabilities); Test the value of the object itself versus the acceptance by law or trust.
Legal tender: Legal tender = cannot be refused for debt settlement; Notes and coins are legal tender. Cheques are not.

How to solve Money: Meaning, Functions and Types questions

Most questions on this topic ask you to name a function, match an example to a function, or classify a type of money. Use the same routine each time.

1Read the option list and note whether the question asks about function, type or feature.
2If it is a function question, ask what money is doing in the example: buying, pricing, saving, paying later or moving value.
3Buying or selling means medium of exchange. Stating prices in rupees means measure of value.
4Loans, instalments or credit sales mean standard of deferred payment. Keeping wealth for the future means store of value.
5Sending money from one place to another or converting assets into cash means transfer of value (or liquidity if cash is the point).
6If it is a type question, check what gives the money its worth: the material (commodity), government order (fiat) or bank credit (credit money).
7Eliminate options that mix up primary and secondary labels, then pick the best fit.

Quickest way: Verb trick for functions

When to use it: Use this when a one-line example is given and you must name the function.

Exchange or pay now: medium of exchange.
Price or value in units: measure of value.
Pay later: deferred payment.
Save or hold: store of value.
Move across places or people: transfer of value.
For types, ask: is the object itself valuable? Yes means commodity. No, but the law backs it means fiat. Bank deposit or cheque means credit.

Common mistakes in Money: Meaning, Functions and Types

Treating store of value as a primary function.
Saving feels as basic as buying, so students group it with the main functions.
Fix: Primary functions are only two: medium of exchange and measure of value. Everything else is secondary or contingent.
Calling a loan repayment example 'medium of exchange'.
Money is being paid, so students focus on the payment itself.
Fix: If the payment is promised for a future date, the function is standard of deferred payment.
Saying fiat money has intrinsic value.
Students assume notes must be backed by something valuable like gold.
Fix: Fiat money is accepted because the government declares it legal tender. The paper itself has negligible value.
Treating cheques as legal tender.
Cheques are widely used in payments, so they look like money.
Fix: A cheque can be refused. Only notes and coins (within legal limits) are legal tender. Cheques are credit instruments.
Confusing commodity money with credit money.
Both are described as 'types' and the names sound alike.
Fix: Commodity money is a physical good with its own worth, such as gold. Credit money is a bank's promise created through lending.

Worked examples

Example 1

A shopkeeper marks the price of a shirt as ₹800 and a pair of shoes as ₹1,500, so that customers can compare them easily. Which function of money is mainly shown?

(A) Store of value
(B) Measure of value
(C) Standard of deferred payment
(D) Transfer of value

Show the solution

Identify the action: prices of different goods are stated in a common unit, rupees.
Stating prices in a common unit is the unit of account role.
This is the measure of value function, which is a primary function.
Store of value is about saving, deferred payment is about future payments, and transfer is about moving purchasing power. None of these is the action here.

Answer: (B) Measure of value

Example 2

Which of the following is an example of fiat money?

(A) A gold coin whose value comes from its metal content
(B) A ₹500 note accepted because the government declares it legal tender
(C) A cheque drawn on a bank account
(D) Cattle used for exchange in a village

Show the solution

Fiat money gets its acceptance from government order, not from material value.
Option A is commodity money, because the metal itself has value.
Option C is a credit instrument based on bank deposits and can be refused, so it is not legal tender.
Option D is commodity money in the form of a good used in barter-type exchange.
Option B has little value as paper and is accepted because of legal tender status. This is fiat money.

Answer: (B) A ₹500 note accepted because the government declares it legal tender

Exam tips

Memorise the two primary and three secondary functions as a fixed list. Many questions test only this classification.
Questions often give a short real-life situation. Convert it to a verb (buy, price, save, pay later, move) and pick the function.
For types of money, always check what gives the money its worth. This separates commodity, fiat and credit money.
Remember that cheques and drafts are not legal tender. This is a favourite statement-based MCQ.
There is no negative marking, so attempt every question. Eliminate options that name the wrong category first.

Practice questions from Money and Banking

Money: Meaning, Functions and Types in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Money: Meaning, Functions and Types: frequently asked questions

What are the primary functions of money?

The primary functions are medium of exchange and measure of value. They directly solve the problems of barter: the need for a double coincidence of wants and the lack of a common unit for pricing.

What is the difference between fiat money and commodity money?

Commodity money has value in itself, like gold or silver coins. Fiat money has little value as an object and is accepted because the government declares it legal tender, as with rupee notes.

What are the secondary functions of money?

They are standard of deferred payment, store of value and transfer of value. They work well only when money keeps a reasonably stable value over time.

Is a cheque money?

A cheque is a credit instrument that transfers bank deposits. It is widely accepted but is not legal tender, because a person can refuse it. Bank deposits are treated as credit money.