Value of Money

Money is the medium of exchange for all the goods and services we trade-in. Interestingly, the value of money is a variable concept. It changes with time. Various forces interplay at the national and global levels to influence it. One of the most exciting concepts revolving around the value of money is the time value of money.

What is the time value of money?

Time value of money denotes that the money available today is worth more than the same amount of money available in the future. It is, primarily, because the money received today can be invested wisely to earn interest. Eventually, the interest increases when compounding, the interest on principal and interest kicks in.

What are the factors affecting the value of money?

Several of the factors that affect the value of money include:

  • Inflation Most people also refer to it as a silent tax. Inflation is the steady increase in the prices of goods and services, leading to a gradual decline in the purchasing power of money.Simply put, suppose you have Rs. 100 and want to buy petrol selling at Rs. 50/litre. Therefore, you can purchase 2 litres. Now, when the price of petrol is at Rs. 75/litre, you can buy only 1.33 litres of petrol with the same Rs. 100 that you had before. In this example, the petrol prices suffer from inflation.
  • DeflationAs against inflation, deflation is a steady decrease in the prices of goods and services, gradually increasing the purchasing power of money.Let us understand deflation from the above example itself. If you could buy 1.33 litres of petrol with Rs 100 earlier, and you can buy 2 litres of petrol with the same amount, its prices have suffered deflation.
  • InterestInterest increases the value of money. Banks operate by charging a higher interest rate from the borrowers and giving lower interest to the depositors. Interest, when compounded over a while, can create generational wealth.
  • Exchange ratesExchange rates are the rates at which you can exchange one currency with the other. They play a prominent role in determining the currency’s value since global forces come into play here. Political stability, public debt, inflation, interest rates, the balance of trade, etc. are a few factors influencing the exchange rates.Exchange rates directly affect the importers and exporters of a country. A falling exchange rate benefits the exporters’ billing in foreign currency, as they receive more local currency in exchange for the same amount of foreign currency. However, the importers are at a loss as they have to pay more for purchasing foreign currency.For example, when the exchange rate is Rs.70/$, an exporter invoicing $1,00,000 will receive Rs.70,00,000. As the dollar rate shoots up to Rs.75/$, the same exporter will receive Rs. 75,00,000 for $1,00,000 invoice.
  • Purchasing powerThe purchasing power of your money is the value it delivers. If money can procure more goods and services at any point, it has more purchasing power, and hence, more value.
  • Demand and supplyThe more the demand for money (or a particular currency), the more value it holds. Similarly, the more the supply of money, the lesser value it has. Hence, the government can’t keep printing money to meet the shortfalls.

Key Takeaway

The value of money directly affects the nation’s and its citizens’ economic conditions. Through its various economic and foreign policies, the Government and the Reserve Bank maintain a check on the value of money when faced with fluctuations.

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