Class XI, Principles of Economics, "Gresham’s Law (Money)"

Gresham’s Law

Concept

Gresham’s law can be stated, as


“Bad money tends to drive good money out of circulation when both of them are full legal tender”.

Thus when two kinds of money good and bad circulate together, other things remaining constant, bad money will remain in circulation and good money will go out of circulation.

Classification of Good and Bad Money

Good and bad money may be classified as:

1. Good money is full valued coins of standard wealth and fineness while bad money is the one, which is debased or worn out.

2. Good money may be superior money of higher substance while bad money will be inferior money of less intrinsic value.

Explanation

In the light of the first classification the law may be stated as:

“Whenever legal tender coins of the same face value but of different weight or degree of fineness are in continuous circulation, the light weight or bad coins tend to drive out the full weight fine coins out of circulation”.


Marshal states the law in the light of second classification as:

“ Money which is inferior in respect to exchange or substance value, commonly shows greater tendency in circulation than those which are superior in this respect”.

Application

The law is applicable in three cases:

Under Mono – Metallism

When coins of same metal but of varying weight or fineness or both circulate together at the same face value, it will be the human tendency to keep a brand new coin and give out the depreciated one. Thus the old and worn out coins will tend to drive newly minted full weight fine coins out of circulation.

Under Bi – Metallism

When gold and silver coins are freely circulated as legal tender, then the over valued coin will drive the under value coin out of the game.

Under Paper Currency

When paper money and metallic money circulate together as standard, however paper money being inferior tends to drive metallic money out of circulation.
The reasons for this are:

• Good money is exported to earn profits.
• Good money is hoarded for later adjustments.
• Good coins are melted and sold as bullion.

Exceptions

The law does not operate when:

• There is a shortage of currency.
• When there is strong public opinion against bad money.