Economics Class 12 Chapter 3 questions and answers: Money and Banking ncert solutions
Textbook | NCERT |
Class | Class 12 |
Subject | Economics |
Chapter | Chapter 3 |
Chapter Name | Money and Banking class 12 ncert solutions |
Category | Ncert Solutions |
Medium | English |
Are you looking for Ncert Solutions for Class 12 Macro Economics Chapter 3 Money and Banking? Now you can download economics class 12 chapter 3 questions and answers pdf from here.
Question 1: What is a barter system? What are its drawbacks?
Answer 1: A barter system is an economic system in which goods and services are exchanged directly for other goods and services without using a medium of exchange such as money. This system relies on the mutual agreement of the parties involved to determine the value of the exchanged items.
Drawbacks of a Barter System:
Double Coincidence of Wants: Finding someone who has the desired item and is willing to trade for what you have can be challenging.
Indivisibility of Goods: Some goods cannot be divided easily for exchange. For example, if a person wants to barter a cow for a number of smaller items, it may not be feasible.
Lack of Standardization: Without a common medium of exchange, it can be difficult to determine fair value, leading to disputes.
Limited Scope: Bartering is usually limited to small-scale transactions and may not be practical for larger or more complex trades.
Storage Issues: Some goods may perish or lose value over time, making it hard to store and trade later.
Inefficient for Large Transactions: Bartering is cumbersome for large transactions, which are more easily facilitated with money.
Record Keeping: Tracking trades can become complex and unmanageable without a standardized system.
Question 2: What are the main functions of money? How does money overcome the shortcomings of a barter system?
Answer 2: The main functions of money are:
Medium of Exchange: Money facilitates transactions by providing a universally accepted medium for buying and selling goods and services, eliminating the need for a double coincidence of wants inherent in bartering.
Unit of Account: Money provides a standard measure of value, allowing for easy comparison of prices and valuation of goods and services, which simplifies accounting and record-keeping.
Store of Value: Money can be saved and retrieved in the future, maintaining its value over time (barring inflation), unlike perishable or non-durable goods in a barter system.
Standard of Deferred Payment: Money allows for credit and loans, enabling transactions that involve future payments, which is challenging in barter systems.
How Money Overcomes Barter Shortcomings:
Eliminates Double Coincidence of Wants: With money, individuals do not need to find someone who has what they want and wants what they have, making exchanges easier and more efficient.
Simplifies Value Assessment: Money provides a common value metric, reducing disputes over the worth of goods and services.
Facilitates Larger Transactions: Money can be easily divided and used for large or complex transactions, which would be cumbersome in a barter system.
Enhances Liquidity: Money can be readily exchanged for any goods or services, making it a more flexible option for transactions compared to physical goods.
Question 3: What is transaction demand for money? How is it related to the value of transactions over a specified period of time?
Answer 3: Transaction demand for money refers to the demand for money for meeting day to day transactional needs. As money is a liquid asset (easily acceptable or exchangeable), everyone has the tendency to hold money. People earn incomes at distinct points of time but consume throughout the entire period. So, people tend to hold money for transaction purposes.
The relationship between the value of transactions and transaction demand for money can be explained as:-
The transaction demand for money in an economy \((M_t^d)\) can be written as
\(M_t^d = k T\)
Where,
v = \(\frac{1}{K}\), represents velocity of circulation of money
T = Total value of transactions in the economy over a period of time
K is a positive fraction \((M_t^d)\) = Stock of money people are willing to hold at a particular point of time.
The transaction demand for money is positively related to the total value of transactions and negatively related to the velocity with which money is circulated.
Question 4: What are the alternative definitions of money supply in India?
Answer 4: The various definitions of money supply in India as prescribed by RBI are M1, M2, M3 and M4.
M1, M2, M3 and M4 are arranged in the descending order of liquidity. In other words, M1 has the highest liquidity and M4 has the least liquidity.
So,
M1 = C + DD + OD
Where,
C = Currency held by public
DD = Net demand deposits of the bank
OD = other deposits held by RBI
M2 = M1 + Savings of the people with Post offices (M2 includes the components of M1 as well as the savings of people with Post office.)
M3 = M1 + Net time deposits with commercial banks (M3 is the most commonly used measure of money supply. It includes the components of M1 and net time deposits of commercial banks.)
M4 = M3 + Total deposits with post offices (excluding National Saving certificate)
Question 5: What is a ‘legal tender’? What is ‘fiat money’?
Answer 5: Legal tender is money that a government declares to be legal for financial transactions within its borders, while fiat money is currency that is not backed by a physical asset:
Legal tender: Money that is legally recognized by a country or political jurisdiction for financial transactions. Legal tender includes coins, paper notes, and currency. It cannot be refused for payment or as a means of exchange.
Fiat money: Money that is declared legal tender by a government but is not backed by a physical asset, such as gold or silver. Fiat money is also known as currency notes and coins. Most currencies in use today are fiat money, including the US dollar and the British pound.
Question 6: What is High Powered Money?
Answer 6: High-powered money is the total amount of currency in circulation and bank reserves, and is also known as the monetary base:
Currency: Notes and coins held by the public
Bank reserves: Cash held in vaults by commercial banks
High-powered money is the foundation for the creation of money supply and the expansion of bank deposits. The Reserve Bank of India (RBI) controls the supply of high-powered money in the economy, and uses it to create incentives for banks to lend money.
So, to sum up, high powered money is
H = C + R
Where
- H − High powered money
- C − Currency
- R − Cash Reserves of commercial banks
Question 7: Explain the functions of a commercial bank.
Answer 7: A commercial bank is a financial institution that provides many services, including:
Providing financial assistance to entrepreneurs: Commercial banks provide financial assistance, guidance, and support to budding entrepreneurs.
Accepting deposits: Commercial banks accept deposits from individuals and businesses in the form of savings, current, and fixed deposits.
Lending money: Commercial banks lend money to individuals and businesses for consumption and investment.
Disbursing payments: Commercial banks pay insurance premiums, rent, loan installments, and other payments.
Collections: Commercial banks collect bills, drafts, and checks.
Safeguarding money: Commercial banks safeguard customer deposits and assets.
Maintaining accounts: Commercial banks maintain and service checking, savings, and custodial accounts.
Providing locker facilities: Commercial banks provide locker facilities for customers to store valuables safely.
Dealing in foreign exchange: Commercial banks help provide foreign exchange to individuals and organizations that import or export goods.
Trading in securities: Commercial banks trade in bonds and securities, allowing customers to buy or sell units.
Discounting bills of exchange: Commercial banks discount bills of businesses, which is considered a profitable investment.
Providing digital banking services: Commercial banks provide digital banking services, such as mobile and internet banking.
Question 8: What is money multiplier? What determines the value of this multiplier?
Answer 8: The money multiplier is the amount of money that banks create as deposits, with each unit of money it is kept as a reserve. It is determined as the ratio of the total money supply to the stock of high powered money in the economy.
Mm = \(\frac{M}{H}\)
Where, MM is the money multiplier
M represents the stock of money
H represents high powered money
Now
\(\frac{M}{H}\) = \(\frac{1+cdr}{cdr=rdr}\) which is > 1
Therefore, the current deposit ratio (cdr) and reserve deposit ratio (rdr) play an important role in the determination of the money multiplier.
Question 9: What are the instruments of monetary policy of RBI?
Answer 9: The monetary policy (credit policy) of RBI involves the two instruments given in the flow chart below:
Quantitative Measures: Quantitative measures refer to such measures which affect the variables, and in turn the overall money supply in the economy is affected. These measures are designed to control of the bank credit.
Instruments of quantitative measures:
(i) Bank rate: The rate at which central bank extends loan to the commercial banks is termed as bank rate. This instrument is like a key at the hands of RBI to control the money supply.
Increase in the bank rate will make the loans to be more expensive for the commercial banks; thereby, creating a pressure on the banks to increase the rate of lending as a result of which, the public capacity to take credit will gradually fall leading to a fall in the volume of credit demanded. The reverse happens in case of a decrease in the bank rate. The increased lending capacity of banks resultant to which, an increased public demand for credit will automatically lead to a rise in the volume of credit.
(ii) Varying Reserve Ratio: The reserve ratio decides the reserve requirements, wherein banks are liable to maintain a certain amount of reserves with the Central Bank.
The three main ratios are:
(a) Cash Reserve Ratio (CRR): It refers to the minimum amount of funds that a commercial bank is supposed to maintain with the Reserve Bank of India, in the form of deposits. For example, suppose the total assets of a bank are worth `500 crores and the minimum cash reserve ratio is 10%. Then the amount that the commercial bank is required to maintain with RBI is `50 crores. If this ratio rises to 20%, then the reserve with RBI increases to `100 crores. Thus, less money will be left with the commercial bank for lending purpose. This will consequently lead to considerable decrease in the money supply. On the contrary, a fall in CRR will lead to an increase in the money supply.
(b) Statuary Liquidity Ratio (SLR): SLR is all about maintaining the minimum reserve of assets with RBI, unlike the cash reserve ratio which is concerned with maintaining a cash balance (reserve) with RBI. So, SLR is defined as the minimum percentage of assets which is required to be maintained in the form of either fixed or liquid assets with RBI. The flow of credit can be reduced by increasing this liquidity ratio and vice-versa. In the previous example, this can be understood as rise in SLR will refrain the banks from injecting money in the economy, thereby contributing towards decrease in money supply. The reverse will be the case if there is a fall in SLR, as it will increases the money supply in the economy.
(iii) Open Market Operations (OMO): Open Market operations are concerned with buying and selling of securities in an open market, to control the money supply in the economy. The selling of securities by RBI will take the extra cash balance out from the economy, thereby limiting the money supply, whereas if the RBI buys securities, then additional money is pumped into the economy stimulating the money supply.
Qualitative Measures: The measures that affect the credit qualitatively are:
(i) Marginal Requirements: The commercial banks’ function of granting loans rests upon the value of the security being mortgaged. So, the banks usually keep a margin, which is said to be the difference between the market value of security and the loan value. For example, a commercial bank grants loan of `1,00,000 against a security of `1,20,000. So, the margin is calculated as 1,20,000 – 1,00,000 = 20,000. When the central bank decides to restrict the flow of money, then the margin requirement of loan is raised and vice-versa in the case of expansionary credit policy.
(ii) Selective Credit Control (SCC): Another instrument of the monetary policy that helps in controlling the flow of credit to particular sector positively and negatively is known as Selective Credit Control. The positive aspect is related to the increased flow of credit to the priority sectors. However, the negative aspect is related to the measures to restrict credit to a particular sector.
(iii) Moral Suasions: It is a technique followed by the Central Bank to pressurise the commercial banks to abide by the persuasion monetary policy. This includes meetings, seminars, speeches and discussions, which describe the present economic scenario and thereby persuading the commercial banks to make changes accordingly. In other words, this is an unofficial monetary policy that is exercised through the power of talk.
Question 10: Do you consider a commercial bank ‘creator of money’ in the economy?
Answer 10: Commercial banks play the important role of ‘money creator’ in the economy. They have the capacity to generate credit through demand deposits. These demand deposits make credit more than the initial deposits.
The process of money creation can be explained by taking an example of a bank XYZ. A depositor deposits Rs.10,000 in his savings account, which will become the demand deposit of the bank. Based on the assumption that not all customers will turn up at the same day to withdraw their deposits, bank maintains a minimum cash reserve of 10 % of the demand deposits, i.e. Rs.1000. It lends the remaining amount of Rs.9000 in the form of credit to other customers. This further creates deposits for the bank XYZ. With the cash reserve of Rs.1000, the credit creation is worth Rs.10,000. So, the credit multiplier is given by:
Credit multiplier = 1/CRR = 1/10% = 10
The money supply in the economy will increase by the amount (times) of credit multiplier.
Question 11: What role of RBI is known as ‘lender of last resort’?
Answer 11: When a commercial bank faces some financial crisis and eventually fails to obtain funds from other sources, then the central bank comes in the picture and plays the vital role of ‘lender of last resort’ by providing them the financial assistance in the form of credit. This role of the Central Bank finally saves the commercial bank from bankruptcy. Thus, the Central Bank also plays the role of guarantor for the commercial banks by maintaining a sound and healthy banking system in the economy.