Money and Banking - Class 12 Economics - Chapter 3 - Notes, NCERT Solutions & Extra Questions
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Extra Questions - Money and Banking | Macroeconomics | Economics | Class 12
If, at the end of the credit creation process, we have total deposits of 50,000, and initial deposits were 10,000, what is the amount of primary deposits?
(A) 60,000
(B) 50,000
(C) 40,000
(D) 10,000
The correct option is (D) $10,000$.
Primary deposits refer to the initial deposits made into the banking system. In this scenario, the primary deposits are stated as $10,000$. Thus, the answer is $10,000$, which corresponds to option (D).
Who was conferred the Central Banker of the Year Award (Global and Asia Pacific) for 2016?
A) Arundhati Bhattacharya
B) C. Rangarajan
C) Naina Lal Kidwai
D) Renu Sud Karnad
E) Raghuram Rajan
The correct answer is E) Raghuram Rajan.
Raghuram Rajan was honored with the Central Banker of the Year Award (Global and Asia Pacific) for 2016. This prestigious award was presented by 'The Banker', a monthly publication that is a part of the Financial Times Group.
James has some money in his wallet, but he does not know the exact amount. When Alice asks him how much money he has, he says, "I have $70 $$ give or take $15 $$." What is the least amount of money James can have?
A) 55
B) 65
C) 75
D) 85
The correct option is A) 55
Explanation:
Interpret the statement: James says he has "$70 give or take $15." This means James’s amount of money, ( m ), could be 15 dollars more or less than 70 dollars.
Write the mathematical expression: The expression "$70 give or take $15" translates to: $$ |m - 70| = 15 $$ This expression indicates that the difference between ( m ) (money James has) and 70 dollars is exactly 15 dollars.
Solve the equation: $$ m - 70 = 15 \quad \text{or} \quad m - 70 = -15 $$
Thus: $$ \begin{align*} m &= 70 + 15 = 85 \ m &= 70 - 15 = 55 \end{align*} $$
Conclusion: Therefore, the least amount of money James can have is $55.
On 1st January 2010, Rakesh had an overdraft of Rs. 8,000, as shown in his cash book. Cheques amounting to Rs. 2,000 had been paid in by him but were not collected by the bank by January 1, 2010. He issued cheques of Rs. 800, which were not presented to the bank for payment up to that day. There was a debit in his pass book of Rs. 60 for interest and Rs. 100 for bank charges. Prepare a bank reconciliation statement for comparing both the balances.
Bank Reconciliation Statement of Mr. Rakesh as on 1st January, 2010
S.N. | Particulars | Amount (+) | Amount (-) |
---|---|---|---|
(I) | Overdraft as per cash book | 8,000 | |
(ii) | Cheques deposited but not yet collected | 2,000 | |
(iii) | Cheques issues but not yet presented | 800 | |
(iv) | Interest charged by bank | 60 | |
(v) | Bank charges | 100 | |
(vi) | Adjusted overdraft as per passbook | 10,360 |
In this table:
Starting with the overdraft reported in the cash book of Rs. 8,000, it reflects the negative balance from Mr. Rakesh's perspective.
Cheques amounting to Rs. 2,000 that were deposited but not collected by the bank are added since these increase the cash book balance.
Cheques worth Rs. 800 issued but not presented reduce the overdraft as these funds are still considered in the bank.
Further, interest and bank charges of Rs. 60 and Rs. 100 respectively are minor deductions from the bank balance as charged by the bank.
Ultimately, these transactions lead to an adjusted overdraft in the passbook amounting to Rs. 10,360, reflecting all unrecorded transactions in the cash book initially.
Why are transactions made in money?
Transactions are primarily conducted using money because it acts as a standard unit of account, which aids in determining the value of goods or services. By using money, individuals can facilitate various exchanges more easily, acquiring any desirable commodity or service efficiently. A significant advantage of this system is its ability to eliminate the need for a double coincidence of wants, which is necessary in a barter system where both parties must have what the other desires.
A man opened a recurring deposit account with a bank and deposited Rs 250 per month. If the rate of interest is $12%$ per annum and the bank pays Rs 10665 on maturity, find the time for which he held the account.
Given values are:
Monthly deposit, $P = \text{Rs}\ 250$,
Annual interest rate, $r = 12%$,
Maturity value = Rs 10665.
Suppose the account is held for $n$ months. The total amount deposited is: $$ Rs\ (250 \times n) $$
The equivalent principal for 1 month is: $$ x = P\left[\frac{n(n+1)}{2}\right] = Rs\left[250 \times \frac{n(n+1)}{2}\right] = Rs\ [125 n(n+1)] $$
Calculating interest: $$ \text{Interest} = x \times \frac{r}{100} \times \frac{1}{12} = Rs\ \left[125 n(n+1) \times \frac{12}{100} \times \frac{1}{12}\right] = Rs\ \frac{5 n(n+1)}{4} $$
The maturity value is the sum of the total deposits plus interest, so: $$ 10665 = 250 n + \frac{5 n(n+1)}{4} $$
Multiplying through by 4 to clear the fraction: $$ 42660 = 1000 n + 5 n(n+1) $$ $$ 42660 = 1000 n + 5 n^2 + 5 n $$ $$ 5 n^2 + 1005 n - 42660 = 0 $$
This is a quadratic equation of the form $an^2 + bn + c = 0$. Here, $a=5$, $b=1005$, and $c=-42660$. $$ n^2 + 201 n - 8532 = 0 $$
Solving this quadratic using the factorization method: $$ n^2 + 237 n - 36 n - 8532 = 0 $$ $$ n(n + 237) - 36(n + 237) = 0 $$ $$ (n + 237)(n - 36) = 0 $$
Setting each factor equal to zero gives $n + 237 = 0$ or $n - 36 = 0$. Thus, $n = -237$ or $n = 36$.
As time ($n$) cannot be negative, thus $n = 36$ months. Converting months to years, we have: $$ 36 \text{ months} = 3 \text{ years} $$
Conclusion: The account was held for 3 years.
Miss Kinnari deposits Rs. 500 each month in a recurring deposit for 2 years at 5% p.a. At maturity, she transfers the proceeds to a fixed deposit account for 1 year, with the interest being compounded half-yearly at the rate of 8% p.a. Find how much money she earns by interest in all.
A) Rs. 1655.20 B) Rs. 1600.20 C) Rs. 1665.20 D) Rs. 1605.20
Miss Kinnari makes monthly deposits of Rs. 500 for 2 years, totaling to 24 months. The interest rate offered is 5% per annum for this recurring deposit (RD). To find out the maturity amount of the RD, we can use the formula for the maturity value of an RD: $$ M = P \left[\frac{n(n+1)}{2} \times \frac{r}{12} \right] $$ where:
(M) is the maturity amount,
(P) is the monthly deposit,
(n) is the total number of deposits,
(r) is the annual interest rate.
For this scenario:
(P = 500),
(n = 24) (2 years),
(r = 5% = 0.05).
Substituting the values, we calculate: $$ M = 500 \left[\frac{24(24+1)}{2} \times \frac{0.05}{12} \right] $$ $$ M = 500 \left[300 \times 0.00416667 \right] $$ $$ M = 500 \times 1.25 $$ $$ M = 625 $$
Adding the total deposits: $$ Total , Deposits = P \times n = 500 \times 24 = 12000 $$
Thus, the maturity amount will be: $$ Total , Maturity , from , RD = 12000 + 625 = 12625 $$
Next, she transfers the amount of Rs. 12,625 to a fixed deposit (FD) account for 1 year at an interest rate of 8% per annum, compounded half-yearly. The formula for compound interest is: $$ A = P \left(1 + \frac{r}{n}\right)^{nt} $$ where:
(A) is the amount accumulated after interest,
(P) is the principal amount,
(r) is the annual interest rate,
(n) is the number of compounding periods per year,
(t) is the time the money is invested for in years.
In this case:
(P = 12625),
(r = 8% = 0.08),
(n = 2) (since interest is compounded half-yearly),
(t = 1) year.
Substituting these values gives: $$ A = 12625 \left(1 + \frac{0.08}{2}\right)^{2 \times 1} $$ $$ A = 12625 \left(1 + 0.04\right)^2 $$ $$ A = 12625 \times 1.0816 $$ $$ A = 13655.20 $$
Thus, the interest earned from the FD is: $$ Interest , from , FD = 13655.20 - 12625 = 1025.20 $$
Adding this to the interest earned from RD: $$ Total , Interest , Earned = 625 + 1025.20 = 1655.20 $$
Thus, the total interest earned by Miss Kinnari from her initial investment in the RD and subsequent investment in the FD is Rs. 1655.20.
The correct answer is Option A: Rs. 1655.20.
Find the total money: 2 banknotes of ₹200 5 banknotes of ₹50 3 coins of ₹2
A) ₹556 B) ₹600 C) ₹650 D) ₹656
To determine the total amount, we simply sum up the values of the banknotes and coins:
2 banknotes of ₹200 each: $$ 2 \times ₹200 = ₹400 $$
5 banknotes of ₹50 each: $$ 5 \times ₹50 = ₹250 $$
3 coins of ₹2 each: $$ 3 \times ₹2 = ₹6 $$
Summing these values gives the total money: $$ ₹400 + ₹250 + ₹6 = ₹656 $$ Therefore, the correct answer is D) ₹656.
Why can't we exchange Monopoly money for buying goods in a shop?
A. Monopoly money does not have any value.
B. It has some value associated with it.
C. It is perishable.
D. It is very expensive.
The correct answer is A. Monopoly money does not have any value.
Monopoly money is specifically designed for use within the Monopoly board game and does not hold any legal or real economic value outside of it. This is the primary reason it cannot be used to purchase goods in a shop, as the currency must have recognized value to be accepted for commerce.
Without money, any relationship will not last long.
A) not lasting
B) not last
C) not lasted
D) no lasting (E) no correction required
The correct answer is Option B: not last. The phrase 'will not last' correctly uses the simple future tense necessary for the sentence.
Which of the following is not a Money Market Instrument?
Treasury Bill
Commercial Paper
Call Money
Bonds
The correct answer is D. Bonds.
In the realm of financial markets, instruments are often categorized based on their maturity and purpose. Money market instruments typically encompass short-term debt securities that have a maturity of one year or less. These include instruments like Treasury Bills (T-bills), Commercial Paper, and Call Money.
On the other hand, Bonds are typically associated with the capital market, as they are long-term investment instruments, usually with a maturity exceeding one year. Capital market instruments include equity shares, debentures, bonds, and preference shares among others.
Thus, of the options listed, Bonds do not qualify as a Money Market Instrument, making option D the correct answer.
Calculate $3 / 4$ of £15.
A) £11.65
B) £12.50
C) £11.25
D) £10.00
To solve for $3/4$ of £15, we start by understanding that we need to find three-quarters of fifteen pounds.
We perform the calculation as follows: $$ \frac{3}{4} \times £15 $$
Proceed by multiplying: $$ = £\left(\frac{3 \times 15}{4}\right) = £\left(\frac{45}{4}\right) = £11.25 $$
Hence, the correct option is C) £11.25.
A person invested a sum of Rs. 2600 in different parts at 4%, 6%, and 8% per annum simple interest. At the end of the year, he got the same interest in all three cases. The money invested at 4% is:
A) Rs. 2200 B) Rs. 800 C) Rs. 1600 D) Rs. 1200
The correct answer is D) Rs. 1200.
Let's denote the amounts invested at 4%, 6%, and 8% simple interest as $x$, $y$, and $z$ respectively. Given that the interest from each part is the same at the end of the year, we have the following equations based on the simple interest formula: $$ \frac{x \times 4 \times 1}{100} = \frac{y \times 6 \times 1}{100} = \frac{z \times 8 \times 1}{100} $$ This can be simplified to: $$ 4x = 6y = 8z $$ or further simplified as: $$ 2x = 3y = 4z $$ From the equation, we can express $y$ and $z$ in terms of $x$: $$ y = \frac{2x}{3}, \quad z = \frac{x}{2} $$ Using the total investment sum of Rs. 2600, the equation becomes: $$ x + \frac{2x}{3} + \frac{x}{2} = 2600 $$ To simplify, find a common denominator (which is 6 here) and solve: $$ 6x + 4x + 3x = 2600 \times 6 \ 13x = 2600 \times 6 \ x = \frac{15600}{13} = 1200 $$ Thus, the money invested at 4% equals Rs. 1200.
The panel set up by the government for considering splitting overseas inflows into two categories - Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI) - is headed by who among the following?
A) Arvind Mayaram
B) Anand Sinha
C) Subir Gokarn
D) KC Chakrabarty
E) Usha Thorat
The correct answer is A) Arvind Mayaram.
The Indian government initiated a four-member committee leading under the guidance of Arvind Mayaram, who was serving as the Economic Affairs Secretary. The main goal of this committee was to clearly define and differentiate between Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII), thus resolving the existing uncertainties between these investment types.
Furthermore, the government has proposed a plan to categorize overseas inflows into two major sectors: Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI). They are considering implementing a minimum composite cap of 49 percent for these combined inflows.
Q. With reference to the Ways and Means Advances (WMA), which of the following statements is/are correct?
It is a long-term loan facility provided by RBI to the Government.
The facility is available to both the Union Government and state governments.
RBI charges interest equal to the repo rate on loans given under WMA.
Select the correct answer using the codes given below:
A) 1 and 2 only B) 1 and 3 only C) 2 and 3 only D) 1, 2, and 3
The correct option is C) 2 and 3 only
Explanation:
Statement 1 is incorrect: Ways and Means Advances (WMA) is not a long-term loan facility but a mechanism used by the national and state governments in India to help tide over the liquidity mismatches. This facility is essentially a short-term loan arrangement with the Reserve Bank of India (RBI).
Statement 2 is correct: The WMA scheme is available to both the Central (Union) and the State Governments. This facility underlines RBI's role as a banker to the government.
Statement 3 is correct: The interest charged on WMA is currently at the repo rate. The ceiling for WMA is decided mutually by the Government of India and the RBI, aligning the interests rates with current short-term economic markers.
Hence, the correct answer with the given options is that statements 2 and 3 only are correct, making C the right choice.
Union Cabinet approved setting up of India Post Payments Bank which will help is furthering the cause of financial inclusion:
Consider the following statements:
Which of the above statement(s) is/are correct?
A. Only 1
B. Only 2
C. Both 1 and 2
D. None of the Above
Correct Option: B Only 2
India Post Payments Bank (IPPB) will be established as a Public Limited Company under the Department of Posts with 100% Government of India (GOI) equity. The services provided by IPPB will be accessible throughout the nation via 650 payments bank branches, associated post offices, and alternative channels that leverage modern technology, such as mobile devices, ATMs, PoS/m-PoS devices, and simplistic digital payment systems.
The India Post Payments Bank will take advantage of the Department's extensive network, widespread reach, and substantial resources. This strategic utilization is intended to provide simple, low-cost, and high-quality financial services, thereby ensuring that these services are easily accessible to customers across the country.
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What is a barter system? What are its drawbacks?
A barter system is an economic system where goods and services are exchanged directly for other goods and services without the use of money as a medium of exchange.
Drawbacks of the Barter System:
- Double Coincidence of Wants: The need for a mutual coincidence where both parties involved desire each other's goods or services, which can be highly improbable and inconvenient.
- Indivisibility of Certain Goods: Some goods cannot be divided into smaller units to facilitate fair trading, making it difficult to achieve an exact exchange of value.
- Lack of a Common Measure of Value: In a barter system, there is no standard measure to determine the value of goods and services, complicating the negotiation process.
- Difficulty in Storing Value: Many goods involved in bartering are perishable or might not retain value over time, making it hard to preserve wealth or save for future needs.
- High Transaction Costs: Searching for a suitable trade partner and negotiating an exchange agreement requires considerable time and resources.
What are the main functions of money? How does money overcome the shortcomings of a barter system?
Main Functions of Money
- Medium of Exchange: Money facilitates transactions between buyers and sellers, removing the limitations of barter systems.
- Unit of Account: It provides a common measure of the value of goods and services, making it easier to compare prices and record debts.
- Store of Value: Money can be saved and retrieved in the future, retaining its value over time, unlike perishable goods.
- Standard of Deferred Payment: It is accepted for settling debts, where payments are deferred to a future date.
Overcoming the Shortcomings of a Barter System
- Removes the Double Coincidence of Wants: In barter systems, two parties need to have exactly what the other wants. Money eliminates this by acting as a universally accepted medium.
- Reduces Transaction Costs: Searching for a barter partner with matching needs can be time-consuming and costly. Money simplifies transactions by being universally accepted and readily divisible.
- Better Preservation of Value: While goods in barter may perish or become obsolete, money generally retains value and can be stored with minimal cost, facilitating saving and future consumption.
Overall, money greatly enhances economic efficiency by simplifying the processes of exchange, valuation, and accumulation of wealth.
What is transaction demand for money? How is it related to the value of transactions over a specified period of time?
Transaction demand for money refers to the amount of money people hold to carry out transactions over a period of time. This need arises because people receive income at certain times but spend it continuously.
The relationship between the transaction demand for money and the value of transactions over a specified period is direct and proportional. Mathematically, it is often expressed as:
$$ M^{d}_T = k \cdot T $$
where:
- ( M^{d}_T ) is the transaction demand for money,
- ( T ) is the total value of transactions (or nominal transactions) in the economy over the unit period,
- ( k ) is a positive fraction reflecting the average proportion of the transaction value that people wish to hold as money.
This formula underscores that as the volume of transactions ( T ) increases, the transaction demand for money also increases proportionately, based on the factor ( k ).
What are the alternative definitions of money supply in India?
In India, the money supply is quantified using various measures labeled as M1, M2, M3, and M4, reflecting different compositions of liquidity. Here are the alternative definitions:
-
M1: This is the narrowest measure and includes the most liquid forms of money. It consists of currency (notes and coins in circulation outside banks) plus demand deposits (deposits that can be withdrawn on demand) at commercial banks.
-
M2: M2 includes all of M1 plus savings deposits with post office savings banks.
-
M3: Known as broad money, this includes M1 plus net time deposits (deposits with a fixed term) at commercial banks.
-
M4: M4 expands on M3 by adding all deposits with post office savings organizations, excluding national savings certificates.
These measures represent varying degrees of money liquidity, with M1 being the most liquid and M4 including forms of money with lower liquidity. The choice of the appropriate measure depends on the economic analysis being conducted.
What is a ‘legal tender’? What is ‘fiat money’?
A legal tender is a form of money that cannot be refused in the settlement of a debt within a country. It is legally recognized and mandatory to accept for all debts or financial obligations. For example, currency notes and coins issued by the authority of a country are considered legal tender.
Fiat money, on the other hand, is conceptually linked but distinct. It refers to any money declared by a government to be legal tender without a commodity backing. Fiat money does not have intrinsic value or use value (like gold or silver). Its value comes exclusively from the trust and acceptance of the people who use it. The promise of the issuing authority, usually a central bank, ensures that fiat money can be exchanged for goods and services. Common examples of fiat money include modern paper currency and coins.
What is High Powered Money?
High Powered Money, also known as reserve money or monetary base, is the total currency (coins and notes) in circulation within an economy plus the currency that is physically held in the vaults of commercial banks. It also includes the reserves held by the banks at the central bank. High Powered Money is crucial because it represents the foundation on which the broad money supply is built and is directly influenced by the policies of the country's central bank. This form of money includes both the physical money circulating in the economy and the money held as reserves, which enables banks to create new loans and thus "multiply" the money supply.
Explain the functions of a commercial bank.
Commercial banks serve pivotal functions in an economy. Here are their main roles:
-
Deposits Acceptance: Commercial banks provide a safe haven for public savings. People and businesses deposit their money in various forms such as savings, checking, and fixed deposit accounts.
-
Loan Provision: They lend funds to individuals, businesses, and governments for various purposes like home purchases, business expansion, or infrastructure development. This credit facilitation boosts economic activity.
-
Payment and Settlement System: Banks facilitate transactions by providing payment services like checks, electronic funds transfer, debit cards, and online banking. This makes business operations smoother and more efficient.
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Money Creation: Through the process of fractional-reserve banking, commercial banks can lend more money than they actually have in reserves, effectively creating money and influencing the money supply in the economy.
-
Financial Intermediation: They act as intermediaries between depositors, who supply capital, and borrowers, who demand capital. This efficient allocation of resources supports economic growth.
-
Wealth Management and Safekeeping of Assets: Banks offer wealth management services including investments, trusts, and insurance products. They also safeguard valuable items in secure vaults (e.g., safety deposit boxes).
-
Foreign Exchange and Trade Facilitation: Banks provide foreign exchange services and financing for international trade, helping businesses conduct transactions in foreign markets.
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Financial Advisory Services: They offer expert financial advice to clients on investments, risk management, and other financial decisions.
Overall, commercial banks are fundamental to the functioning of modern economies, facilitating transactions, credit provision, and financial services.
What is money multiplier? What determines the value of this multiplier?
The money multiplier is a concept that describes the extent to which the money supply is increased through the banking system. It is defined as the ratio of the total amount of money in circulation (including cash and bank deposits) to the monetary base (total bank reserves).
The formula for the money multiplier is: $$ \text{Money Multiplier} = \frac{1}{\text{Cash Reserve Ratio (CRR)}} $$
The value of the money multiplier is determined by the Cash Reserve Ratio (CRR), which is the percentage of reserves that banks are required to hold against deposits. A lower CRR leads to a higher money multiplier, allowing banks to lend more money based on the same amount of reserves, thereby increasing the money supply. Conversely, a higher CRR reduces the money multiplier, limiting the ability of banks to expand the money supply.
What are the instruments of monetary policy of RBI?
The instruments of monetary policy of the Reserve Bank of India (RBI) include:
- Cash Reserve Ratio (CRR): The percentage of deposits that banks must hold as cash reserves with the RBI.
- Statutory Liquidity Ratio (SLR): The percentage of deposits that banks must maintain as liquid assets.
- Bank Rate: The rate at which the RBI lends money to commercial banks.
- Open Market Operations (OMO): Buying and selling of government securities in the open market to adjust the liquidity in the system.
- Repo Rate and Reverse Repo Rate: The repo rate is the rate at which RBI lends short-term money to banks, and the reverse repo rate is the rate at which RBI borrows money from banks.
These tools are used by the RBI to control the supply of money and achieve macroeconomic objectives such as controlling inflation and stimulating economic growth.
Do you consider a commercial bank ‘creator of money’ in the economy?
Yes, a commercial bank can be considered a creator of money in the economy. Here's how:
Commercial banks facilitate the creation of money primarily through the process of deposit multiplication, where they utilize deposits made by customers to extend loans to other customers. In simple terms, when a bank receives deposits, it is not required to keep all of this money as reserves. It retains a fraction of the deposit as per regulatory requirements and lends out the rest.
This lending activity results in new deposits created for other customers. For instance, when a bank lends money, the recipient usually deposits this money back into the bank or another bank, increasing the total deposits within the banking system beyond the initial funds deposited. This mechanism, often illustrated through the concept of a money multiplier, shows how multiple rounds of lending and depositing can significantly increase the money supply.
This process effectively makes commercial banks creators of money, expanding the money supply in the economy through lending activities.
What role of RBI is known as ‘lender of last resort’?
The role of the Reserve Bank of India (RBI) known as the ‘lender of last resort’ refers to its function of providing funds to the commercial banks during financial emergencies when no other sources of funds are available. This role ensures that commercial banks have access to necessary funds for stability and to avoid liquidity crises, thereby maintaining trust and stability within the financial system.
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Money and Banking Class 12 Notes: Comprehensive Guide with Detailed Explanations
Introduction to Money and Banking
Understanding the role of money and banking in the economy is crucial for students in Class 12. This comprehensive guide covers the essentials of money, its functions, and the banking system's operations to facilitate economic exchanges.
What is Money?
Money is defined as the commonly accepted medium of exchange in an economy. It plays an essential role in facilitating transactions and smoothening the economic exchanges between individuals and businesses. In the absence of money, barter exchanges occur, which require a double coincidence of wants, making them highly inefficient and impractical.
Functions of Money
Money performs several critical functions in a modern economy:
- Medium of Exchange: Money facilitates trade by eliminating the inefficiencies of barter systems.
- Unit of Account: It provides a standard measure for valuing goods and services.
- Store of Value: Money allows individuals to store wealth and defer consumption until needed.
- Standard of Deferred Payment: It enables borrowing and lending by serving as a standard for future payments.
Cashless Transactions in Modern Economy
The shift towards cashless transactions is becoming increasingly significant. Digital payment systems, such as e-wallets and Aadhaar-enabled payment systems, are promoting financial inclusion and reducing reliance on physical cash.
Demand for Money
The demand for money in an economy is driven by two primary motives:
- Transaction Motive: Money is needed to carry out transactions smoothly.
- Speculative Motive: Money is held to speculate and take advantage of future changes in interest rates.
Influence of Income and Interest Rates
- A rise in income increases the demand for money for transactional purposes.
- Higher interest rates decrease the demand for money, as individuals prefer to invest in interest-earning assets.
Supply of Money in the Economy
Money supply comprises several components:
- Cash
- Bank Deposits
The central bank and commercial banks play pivotal roles in the creation and management of money supply.
Central Bank's Functions
The central bank, such as the Reserve Bank of India (RBI), performs multiple functions:
- Issuance of currency.
- Control of the money supply through various monetary tools.
- Acts as a banker to the government and other banks.
Commercial Banks and Money Creation
Commercial banks accept deposits and lend money, which facilitates credit creation. This process results in a multiplier effect, increasing the overall money supply in the economy.
graph TB
A[Deposit: ₹100] --> B[Reserves: ₹20]
A --> C[Loaned Out: ₹80]
C --> D[Deposited: ₹80]
D --> E[Reserves: ₹16]
D --> F[Loaned Out: ₹64]
F --> G[Deposited: ₹64]
The above flowchart illustrates the money multiplier process, showing how initial deposits can lead to multiple cycles of credit creation.
Policy Tools to Control Money Supply
The RBI uses several tools to influence money supply:
- Cash Reserve Ratio (CRR): Percentage of deposits banks must hold as reserves.
- Open Market Operations: Buying and selling of government securities.
- Repo and Reverse Repo Rates: Rates at which the central bank lends to or borrows from commercial banks.
Measuring Money Supply
Money supply is measured in various forms:
- Narrow Money (M1, M2): Highly liquid forms of money.
- Broad Money (M3, M4): Includes less liquid forms of money.
These measures help in analysing the liquidity and financial health of the economy.
Conclusion
A thorough understanding of money and banking is essential for grasping the nuances of economic transactions. Money not only facilitates exchange but also acts as a measure of value, a store of wealth, and a standard for deferred payments. The roles of central and commercial banks as well as the instruments used to control money supply highlight the complexity and significance of the banking system in modern economies.
Additional Resources for Students
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Flowchart on Credit Creation:
graph TD A[Initial Deposit] --> B[Reserves] A --> C[Loans] C --> D[Re-Deposits] D --> E[New Reserves & Loans]
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Image: Economic Transaction Involving Money Exchange
These resources provide a visual aid to better understand the flow of money within the banking system and the nature of economic transactions.
Explore the fascinating world of money and banking, as these concepts form the bedrock of our modern economy.
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