Question 1. What is a barter system? What are its drawbacks?
Answer : Barter System Barter system refers to the exchange of goods for goods.
e.g., If a person exchange wheat with rice. It is a barter system.
Drawbacks of Barter system are as follows
Drawbacks of Barter system are as follows
- Difficulty of Double Coincidence of Wants It is not necessary that goods in possession of two different individuals are needed by each other.
- Lack of a Common Unit of Value It implies that the goods which are exchanged not measured in a common unit.
- Lack of a System for Future Payments Evolution is difficult thus future payments would not be possible.
Question 2. What are the main functions of money? How does money overcome the shortcomings of a barter system?
Answer The functions of money can be divided in two categories-
1. Primary or (Main functions)
2. Secondary functions
2. Secondary functions
I. The primary functions are of two types
- Medium of Exchange It can be used to make payment for all transactions of goods and services.
- Measure of Value It means that the value of each goods and services are measured in the monetary unit.
II. Secondary functions are of three types
- Deferred Payments Money is used to make the future payments.
- Store of Value It implies store of wealth.
- Transfer of Value Money is used as a convenient mode of transfer of value.
The money over comes from the short comings of the barter system in a following manner
- (a) Use of money removed the difficulty of double coincidence of wants in the barter system.
- (b) Money facilitates storage of value.
- (c) Use of money removed the difficulty of division of commodity.
- (d) It removed the difficulty of medium of exchange.
- (e) Use of money removed the difficulty of deferred payments.
Question 3. What is transaction demand for money? How is it related to the value of transactions over a specified period of time? Answer The transaction motive relates to the demand for money to meet day-to-day transactions.
According to Keynes, “Transaction demand for money is positively associated with the level of income, as higher the level of Income, larger would be the size of money holdings for transactions. The relationship between the value of transactions and transaction demand is
Question 4. Suppose a bond promises ~ 500 at the end of two years with no intermediate return. If the rate of interest is 5% per annum what is the price of the bond?
Question 5. Why is speculative demand for money inversely related to the rate of interest?
Answer The interest rate vanes inversely with the market value of bonds because when interest rate rises. market value of bonds falls. Hence.
demand for money tor speculative motive becomes less at high rate of Interest and becomes large at low rate of Interest.
demand for money tor speculative motive becomes less at high rate of Interest and becomes large at low rate of Interest.
Question 6. What is ‘liquidity trap’?
Answer Liquidity Trap It is a situation of very low rate of Interest in the economy where every economic agent expects the interest rate to rise in
future and consequently bond price falls, causing capital loss. Everyone holds her/his wealth in money and speculative demand for money is infinite.
future and consequently bond price falls, causing capital loss. Everyone holds her/his wealth in money and speculative demand for money is infinite.
Question 7. What are the alternative definitions of money supply in India?
Answer There are four alternative measures 01 money supply in India.
These are known as
M1, M2, M3 and M4 define as
M1 => Currency with public + Demand deposits + Other deposits with RBI
M2 => M1 + Saving with post office saving account
M3 => M1 + Net time deposits with banks
M4 => M3 + Total deposits with post office (except NSC)
M1 => Currency with public + Demand deposits + Other deposits with RBI
M2 => M1 + Saving with post office saving account
M3 => M1 + Net time deposits with banks
M4 => M3 + Total deposits with post office (except NSC)
Question 8. What is a ‘legal tender? What is ‘fiat money’?
Answer Legal Tender Legal tender refers to the money which can be legally used to make payment of debts or other obligations. Fiat Money Fiat money refers to the money which is backed with order of the government under law. It must be accepted for all debts.
Question 9. What is high powered money?
Answer High Power Money It means currency (coins and notes) held by the public and cash reserves with the commercial banks.
Question 10. Explain the functions of a commercial bank.
Answer Function of Commercial Bank
The function of commercial bank divided into three categories
(i) Primary Functions A commercial bank performs two primary functions
(a) Accepting Deposits Commercial bank accepts deposits from public by several kinds of account like
- (a) Current account
- (b) Fixed deposit account
- (c) Saving account
- (d) Reccuring deposit account
(b) Providing Loans and Advances A commercial bank provides loans and advances both for productive purpose as well as consumption (household) purpose. The commercial bank provides-cash credit. demand loans and short term loans.
(ii) Secondary Functions In addition to the primary functions. banks also perform the following secondary functions
(a) Overdraft Facility It refers to a facility in which a account holder is allowed to overdraw amount IJptOlimit from his current account.
(b) Discounting Bills of Exchange The commercial bank provides the facility of discounting bill belore the date of maturity.
(b) Discounting Bills of Exchange The commercial bank provides the facility of discounting bill belore the date of maturity.
(iii) Agency Functions A commercial bank acts as an agent of his customer. Some of the agency functions are
- (a) Transfer of funds.
- (b) Collection and payment of various items.
- (c) Purchase and sale of foreign exchange.
- (d) Purchase and sale of securities
- (e) Act as consultant.
- (f) Provide locker facility
- (g) Provide information and statistics data to the customers.
Question 11. What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier?
Answer Money multiplier measures the amount of money that the banks are able to create in the form of deposits with each unit of money it keeps as
reserves. Its value determined in ratio of total money supply to the stock of the high powered money in an economy. as
reserves. Its value determined in ratio of total money supply to the stock of the high powered money in an economy. as
Tile currency deposit ratio (cdr) and reserve deposit ratio (rdr) plays an important role in determining money multiplier. cdr is the ratio of money held by the public.
cdr = C/DD ratio of the total deposit keptt by commercial banks. rdr is the proportion of the total deposit kep by commercial banks.
Question 12. What are the instruments of monetary policy of RBI? How does RBI stabilise money supply against exogenous shocks?
Answer Following are the instruments of monetary policy of RBI
(i) Quantitative Instrument It affects the overall supply of money and credit in the economy. These instruments are
- (a) Bank Rate The rate at which RBI gives credit to the commercial banks. A low or high banks rate encourages banks to keep small proportion of their deposits as reserve which in result either reduce the flow of credit or increase the flow of credit.
- (b) Open Market Operations It refers to the sale or purchase of securities by RBI in the open market.
- (c) Reserve Ratios Ratios like CRR (Credit Reserve Ratio) (Statutory Liquid Ratio) SLR are playing an important role as the quantitative instrument.
(ii) Qualitative Instrument These instruments direct or restrict the flow of credit to the specified areas of economic activity. These instruments are
- (a) Margin Requirements It refers to the difference between the current value of the security offered for ioans and value of loans granted.
- (b) Rationing of Credit It refers to the fixation of quotas for different business activities.
- (c) Moral Suasion It implies informal suggestion by the RBI to commercial banks to co-operate with the general monetary policy.
Sometimes because of inflow of foreign currency into the market. RBI plays an important role in controlling external shock Suppose foreigner decide to make investment in Indian bonds. The seller of the bond exchange the foreign currency into rupees from a commercral bank
The commercial bank deposits the currency in RBI which increases the assets and liabilities in the balance sheet, on the other hand, commercial
bank’s total reserves unchanged. In order to overcome from this situation RBI sells the securities in open market or sterilises the economy against
adverse external shocks. This process is known as sterrlisation.
bank’s total reserves unchanged. In order to overcome from this situation RBI sells the securities in open market or sterilises the economy against
adverse external shocks. This process is known as sterrlisation.
In this way, RBI stabilise the money supply against exogenous shocks.
Question 13. Do you consider a commercial bank ‘creator of money’ in the economy?
Answer Yes, commercial bank acts as a creator of money in the economy. They create credit in the from of demand deposit related to the loans
offered by them. Thus. banks create credit by advancing loans.
offered by them. Thus. banks create credit by advancing loans.
Question 14. What role of RBI is known as lender of last resort?
Answer When commercial bank fails to get their financial requirements from other sources in the market. then they approach the RBI (central bank). The central bank gives loan to commercial banks . This situation termed as a lender of the last resort. The central bank ensures that the
banking system does not suffer any set-back and money market remains stable.
banking system does not suffer any set-back and money market remains stable.