What is the Value of Money?

By the term “value of money” is meant the purchasing power of money its buying capacity, i.e., the quantity of goods and services a unit of money can buy.

Obviously, the purchasing power of money depends upon the level of prices of the goods and services to be purchased.

Thus, the lower price level, the greater would be the purchasing power of money; and the higher the level of prices, the lower would be the purchasing power.

Hence, the purchasing power of money changes inversely with the price level. Thus, the value of money is the reciprocal of the price level general prices. To express symbolically, thus:

Here, the value of money is defined and measured in relation to “the general level of prices.” But the general level of prices is based on a mixture of the price level of all commodities, which means nothing specifically.

Prof. Hayek as such regards the general price level as a mere abstraction. It must be remembered that an individual, however, is not concerned with the general value of money.

He is primarily interested at any given time in the prices of those goods and services which he wants to purchase. Therefore, he will try to reckon the value of his money in terms of such goods only.

The purchasing power of his money is affected by the prices of only those goods which he wants to purchase. So, the value of money is not the same to every person when he goes out to spend it.

One must, therefore, agree with Crowther that “the value of money without qualifications is almost meaningless.” Economists, in order to get over this difficulty, arbitrarily laid down certain standards to measure the value of money. Usually, three such standards are distinguished:

(i) The Wholesale Standard:

According to this standard, the value of money is expressed in terms of all those goods that are transacted in wholesale markets. The wholesale standard of value of money, measured through the wholesale price indices, is usually preferred because wholesale prices are recorded regularly, and are readily available.

(ii) The Consumption Standard:

By this standard, the value of money is expressed in terms of those goods and services that ordinarily constitute the consumption items of an average family.

Thus, through consumers’ price index number, the value of money is measured. So, it is called the retail value of money.

In formulating such a standard, however, a difficulty arises in drawing up a standard list of commodities of common consumption, because the consumption pattern differs from family to family, depending upon individual tastes, incomes, etc.

This may involve extensive inquiries. Moreover, as there are no standard retail price quotations available, the difficulty is aggravated.

(iii) The Labour Standard:

This standard denotes the value of money in obtaining labour services. It is generally determined from the rate of wages payable for a day’s work. This standard is also called the labour value of money. Here again, a difficulty is encountered on account of lack of homogeneity in labour units.

Indeed, all these conceptions are arbitrary and are merely intended to reduce the complexity involved in the definition of the value of money as the reciprocal of “the general level of prices.”

Nonetheless, an exact denomination of the value of money can not be given. It is very complicated and cannot be defined in absolute terms of purchasing power, because that would involve comparison of the values of all the commodities in the economy that are exchanged against money.

It becomes impracticable owing to the great variety and complexity of modem business transactions. Even with these narrowed-down categories of the value of money [viz., wholesale standard, consumption standard and labour standard) we cannot measure them satisfactorily.

For instance, if we want to find out the wholesale value of money, it requires the preparation of long unwieldy lists of various commodities whose prices are quoted in the wholesale markets, e.g.

We may have to find out the value of a rupee in terms of wheat, rice, cloth, soap, sugar, raw materials and machinery and so on in accordance with their respective wholesale prices.

Indeed to prepare such a list is a complicated task. Thus, any attempt to measure the value of money in any of its standards would be a very lengthy task, and the list, though accurate, would be beyond our comprehension. Hence, we cannot find out really what is the wholesale, the retail or the labour value of money in the absolute sense.

In practice, therefore, it is not possible to measure the absolute value of money. Moreover, in practice, actually what needs to be measured is not so much the value of money itself as changes in the value of money over a period of time. ¹

Though we cannot measure the value of money at any given time, we can certainly know, in a broad sense, how the value changes in the course of time.

One is always interested in finding out whether his money’s purchasing power has risen/ or fallen over a period of time and, if so, to what extent. It is possible to know this by measuring the changes in the value of money from time to time.

The value of money is, thus, important only in a relative sense, i.e., for comparing its value at one time with its value at another. As a matter of fact, we can measure only the relative changes in the value of money over a period of time, but not the value of money in any absolute sense.