Detailed, Step-by-Step NCERT Solutions for Class 12 Economics Chapter 3 Money and Banking were solved by Expert Teachers as per NCERT (CBSE) Book guidelines covering each topic in chapter to ensure complete preparation.
Money and Banking NCERT Solutions for Class 12 Economics Chapter 3
Money and Banking Questions and Answers Class 12 Economics Chapter 3
Question 1.
What is a barter system? What are its drawbacks?
Answer:
Economic exchanges without the mediation of money are referred as barter system. In other words, barter system is a system under which goods are exchanged for goods.
Following are the drawbacks of barter system:
(i) Lack of Double Co-incidence of Wants: The barter system requires that a person having a surplus of one commodity should be able to find another person who wants that commodity as well as has something acceptable to offer in exchange. This is called double coincidence of wants, which is hard to find.
(ii) Lack of Common Measure ofValue: Different commodities are of different value. There is no common unit of measuring value under the barter system. It is difficult to decide the proportion in which the two goods are to be exchanged.
(iii) Lack of Standard of Deferred Payments: The barter system lacks any satisfactory unit to engage in contracts involving future (deferred) payments. It may be due to disagreement regarding the specific commodity and its quality. Moreover, there is a risk of an increase or decrease in the value of the good over time, thus benefitting the lender or borrower of the good respectively.
(iv) Difficulty of Storage of value: It is difficult to store wealth for further use. Most of the goods like wheat, rice, cattle, etc. deteriorate with the passage of time or involve heavy storage cost.
(v) Difficulty of Transfer of Value: Under barter system, wealth in the form of goods cannot be transferred from one place to another. It is a difficult task as it requires a lot of time and resources.
Question 2.
What are the main functions of money? How does money overcome the shortcomings of a barter system? (C.B.S.E Outside Delhi 2011 Comp.)
Answer:
The following are the important functions of money:
(i) Medium of Exchange: Money acts as an intermediary in the exchange transactions of goods and services. Money solves the problem of double coincidence of wants by acting as a medium of exchange for all goods and services.
(ii) Unit of value: Money acts as a convenient unit of account The value of all the goods and services can be expressed in monetary units. Money as a unit of value helps in measuring the value of exchange for various goods and services.
(iii) Store of value: Money is not a perishable item and its storage costs are also considerably low. Moreover, it is acceptable to anyone at any point of time. Thus, money acts as a store of value for individuals. Under barter system, wealth in the form of goods like wheat, rice, cattle, etc. deteriorate with the passage of time or involve heavy storage cost. However, wealth can easily be stored in the form of money for future use.
(iv) Standard of Deferred Payments: Money acts as standard in terms of which future or deferred payments are stated because money maintains a constant value o\ c a period of time. Under barter system, goods could not be used for future contracts due to the risk associated with type, quality and value of the goods. Money exchange has no such problem.
Question 3.
What is transaction demand for money? How it is related to the value of transactions over a specified period of time?
Answer:
Transaction demand for money is a measure of the money held by the public to carry out ordinary day to day transactions. People tend to hold their incomes to undertake transactions over a certain period of time. The relationship between transaction demand for money and value of transactions can be expressed as:
\(\begin{aligned}
M_{T}^{\phi} &=k \cdot T \\
\frac{1}{k} M_{T}^{d} &=T \\
v_{0} M_{T}^{d} &=T
\end{aligned}\)
where \(M_{T}^{d}Md\)= Transaction Demand for Money
v =\(\frac{1}{k}= \) Velocity of Circulation of Money (k being a positive fraction)
T = Total Value of Nominal Transactions in the economy over a time period
The transaction demand for money is positively related to total value of transactions and negatively related to the velocity with which the money is circulated in the economy.
Question 4.
What are the alternative definitions of money supply in India?
Answer:
Money supply is a stock variable. It is the total stock of different types of money (currency in circulation and deposits) available in an economy at a specific point of time. In India,-‘M(, M2, M3, M4 are the four alternative measures of money supply.
They are defined as follows:
M1 = CU + DD
M2= M1 Savings deposits with post office saving banks
M3 = M1 + Time deposits of commercial banks
M4 = M3 + Total deposits with post office savings organisations (excluding National Savings Certificates)
CU = Currency (notes and coins held by public)
DD = Net demand deposits held by the commercial banks
Question 5.
What is a ‘legal tender? What is ‘fiat money’?
Answer:
Legal tender is the money that, by law, must be accepted as a medium of exchange and payment for debt by the citizens of a country. It cannot be refused by any person against the payment for transactions. Everyone is bound to accept it because its non-acceptance is an offence. Example of legal tender is currency notes issued by Reserve Bank of India. Fiat money refers to the currency notes and coins made legal tender by the order of the government. They do not have intrinsic value like a gold or silver coin.
Question 6.
What is high powered money?
Answer:
The total liability of the monetary authority of the country (RBI in India) is called the monetary base or high powered money. It consists of currency (notes and coins in circulation with the public and vault cash of commercial banks) and deposits held by the government of India and commercial banks with RBI. High powered money can be expressed with the help of equation:
H = CU +R
= cdr x DD + rdr x DD
= (cdr + rdr) DD
Where, H = High powered money
cdr= Currency Deposit Ratio
rdr= Reserve Deposit Ratio
Question 7.
Explain the functions of a commercial bank.
Answer:
The functions of a commercial bank are classified below:
I. Primary Functions: Following are the primary functions of a commercial bank:
(i) Acceptance Deposits: Commercial banks accept deposits from the public and lend this money to companies and other people for investment projects. The banks offer interests on deposits to the deposit holders. Deposits are broadly into:
- Demand Deposits: These are, payable by the banks on demand from the account holder. For example: Current and Savings Account Deposits
- Time Deposits: These deposits have a fixed period to maturity. For example: Fixed Deposits.
(ii) Advancing Loans: Extending loans is another important primary function of the commercial banks. After keeping a certain portion of the deposits as reserves, the bank gives the balance to borrowers in the form of loans and advances.
The rate at which banks lend out their reserve to investors is called the lending rate. Lending by commercial banks consists mainly of cash credit, demand and short-term loans to private investors and banks. The credit worthiness of a person is judged by his current assets or the collateral (a security pledged for the repayment of a loan) he can offer.
2. Secondary Functions: Following are the secondary functions of a commercial bank:
- To transfer funds from one place to another.
- To collect funds on behalf of the customers.
- To purchase and sell shares and debentures on behalf of the customers.
- To provide income-tax consultancy.
- To pay bills and insurance premium as per customer’s direction.
- To provide facility of travellers’ cheque and letter of credit.
Question 8.
What is money multiplier? What determines the value of this multiplier?
Answer:
Money Multiplier: Money multiplier may be defined as the ratio of the stock of money (money supply) to the stock of high powered money in an economy. That is,
Money Multiplier = MoneyStock
\(\begin{aligned}
\text { Money Multiplier } &=\frac{\text { Money Stock }}{\text { High Powered Money }} \\
&=\frac{M}{H}
\end{aligned}\)
Since the stock of money is always greater than the high powered money, the value of money multiplier is always greaterthan one.
Following ratios play an important role in the determination of the value of the money multiplier:
(i) Currency Deposit Ratio: Currency deposit ratio is the ratio of currency held by public to the net demand deposits held by the commercial banks.
Currency Deposit Ratio = \(\frac{C U}{D D}\)
(ii) Reserve Deposit Ratio: Reserve deposit is a ratio of total deposits, which the commercial banks keep as reserves to the net demand deposits held by them.
Reserve Deposit Ratio = \(\frac{R}{D D}\)
where, CU = Currency (notes and coins held by public)
R = Reserves held by the commercial banks
DD = Net demand deposits held by the commercial banks
Question 9.
What are the instruments of monetary policy of RBI?
Answer:
Following are the instruments of monetary policy of RBI:
Open Market Operation: Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. RBI purchases or sells government securities to the general public in a bid to increase or decrease the stock of high powered money in the economy.
Bank Rate Policy: Bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to the commercial banks. Higher bank rate reduces the lending capacity of the commercial banks as they get funds at a higher interest rate from RBI. Consequently, credit contracts in the economy as public borrows less at high rate of interest.
Similarly, lower bank rate increases the lending capacity of the commercial banks as they get funds at a lower interest rate from RBI. Consequently, credit expands in the economy as public borrows more at low rate of interest
Varying Reserve Requirements: Cash Reserve Ratio (CRR) is the minimum fraction of the total deposits with the commercial banks, which they are required to keep with the central bank. Statutory Liquidity Ratio (SLR), on the other hand, is the minimum fraction of the total deposits with the commercial bank, which they are required to maintain in the form of specified liquid assets.
A high or low value of CRR or SLR helps increase or decrease the value of reserve deposit ratio, thus diminishing or increasing the value of the money multiplier and money supply in the economy.
Question 10.
Do you consider a commercial bank ‘creator of money’ in the economy?
Answer:
A commercial bank is a ‘creator of money’ in the economy. The process of money creation can be explained as below:
Suppose every bank is required to maintain 10 percent of its total deposits in the form of cash reserves. Further assume that Bank A receives a primary deposit of? H. Bank A will keep 10 percent of ₹ H (₹ 0.1H) as reserves and will lend out the balance, ₹ 0.9H, to the borrowers. People who receive ₹ 0.9H from Bank A are expected to spend the amount or pay their creditors, and hence, the money will come back to the banking system, say in Bank B.
After keeping a reserve of ₹ 0.09H (10 percent of ₹0.9H), Bank B will lend out the balance, ₹ 0.81H, to the borrowers. Again, those who receive ₹ 0.81H from Bank B are expected to spend the amount, and hence, the money will come back to the banking system, say in Bank C.
After keeping a reserve of ₹ 0.081H (10 percent of ₹ 0.81H), Bank C will lend out the balance, ₹ 0.729H, to the borrowers. This process of deposit turning into loan or investment, which again becomes a new deposit, goes on until the primary deposit of ₹ H is completely exhausted. The total of all the deposits resulting from primary deposit will be 10 times of ₹ H.
Question 11.
What role of RBI is known as ‘lender of last resort’?
Answer:
If all the account holders of all commercial banks in the country want their deposits back at the same time, the bank will not have enough means to satisfy the need of every account holder and there will be bank failures. The Reserve Bank of India plays a crucial role in the situation of Bank run. During crisis, if commercial banks fail to meet the obligations of their depositors, the central bank plays a crucial role.
The central bank stands by the commercial banks as a guarantor and extends loans to ensure the solvency of the latter. This saves the commercial banks from possible breakdown. The central banks always provide the help needed by the commercial banks. This function of the central bank makes it the ‘lender of the last resort’.