CPT Section C General Economics Chapter 8 Unit 1 CA Shweta Poojari

1.Concept of Barter System

2.Meaning & Definition of Money

3. Functions of Money

4. Classification of Money

5. Money Supply & Money Stock in India

6. Multiple Choice questions

Barter system refers to direct exchange of goods & Services i.e. Exchanging goods/services available with us to buy the goods/services we need, because there was no standard mode for settlement of transactions like “Money”. Eg: One person has surplus of wheat wants cloth and another person having surplus of cloth wants wheat.

Lack of Double Coincidence

Lack of Divisibility

Lack of Measure of Value

In Barter system person having a surplus of one commodity should be able to find another person who needs it and has something to offer in exchange.

There are certain goods which are useful as a whole. Eg: Horse, Cow, Table, etc.

These cannot be exchanged in pieces for different things for barter.

There is no common measure in barter system.

Suppose a Goat is to be exchanged for rice, it is difficult to decide the quantity of rice worth a goat.

Money is also defined as, “Money is What money Does” i.e. anything that performs the function of money is money.

Anything that is generally accepted as a medium of exchange.

According to Robertson “Money is anything which is widely accepted in payment for goods, or in discharge of other kinds of business obligations.”

According to Kent “Money is anything which is commonly used and generally accepted as a medium of exchange or as a standard of value.”

Primary Secondary Contingent

Medium of exchange Measure or unit of value

Store of value Standard for deferred payment Transfer of value

Basis of credit Liquidity Maximum utilization of resources Guarantor of solvency Distribution of National Income

• Money as a medium of exchange is used in the sale and purchase of goods and services.

Medium of Exchange:

• Money measures value of goods and services and facilitates sale and purchase of goods and services. The value of each good and service is expressed as price of the commodity.

Measure of Value:

• Money serves as store of value (i.e. Wealth in liquid form). In modern world, people want to have some currency notes or coin in their pocket, home, bank account etc. to use any time for purchase of anything.

Store of Value :

• Money is also helpful in payment for goods and services after lapse of time i.e. debts, loans and future transactions can be settled.

Standard for deferred payments :

• Sale and purchase of movable and immovable property can also be made with the help of money.

Transfer of Value:

• It is the changes in the quantity of money that brings about changes in supply of credit. The entire strength of credit system is based upon money.

Basis of Credit:

• Money is the most liquid asset which can be converted into other assets quickly.

Liquidity:

• In context of production & consumption, the producers and consumers can make a Cost-Benefit analysis to ensure optimum utilization of resources.

Maximum utilization of resources:

• Money is the guarantor of solvency of a person. If a person is able to pay his debt, he will be called solvent. On the other hand, if a person fails to honor his obligations, he will be called as insolvent.

Guarantor of

Solvency:

• Money is helpful in measuring the contribution to national income of various sectors of the economy, people of the country.

Distribution of National

Income:

In Consumption & Trade (as a medium of exchange)

In Budgeting & Economic Policy formation (Expenditures & Revenues expressed in money terms)

To measure National Income

In Production (to compensate the factors of production i.e. rent, wages, etc)

Directs Economic Trends (directs idle resources into productive channels)

Encourages Division of Labour & Occupational Specialization

Fiat Money & Fiduciary Money:

Fiat money, also known as currency is a legal tender . It has legal power to discharge debts. The creditor cannot refuse to accept it.

Fiduciary money are the demand deposits of the bank. It is accepted as money on the basis of the trust that issues it command . A person can refuse to accept bank money (Cheque), because there is no guarantee that the cheque will be honoured.

Full Bodied Money, Representative Money & Credit Money:

Full Bodied Money-

• The money, whose value as a commodity for non-monetary purposes is as great as its value as money is known as full-bodied money.

• Eg: Gold coins in gold standards, Silver coins in silver standards or Gold and silver coins in bimetallic standard.

Full Bodied Money, Representative Money & Credit Money:

Representative Money-

• Instead of actual metallic coins paper money is used.

• The money has higher face value than its intrinsic value is known as representative full bodied money.

Full Bodied Money, Representative Money & Credit Money:

Credit Money-

• The money whose value is greater than the commodity

value of the material from which the money is made is known as credit money.

• It can be in forms of token money, circulating promissory notes issued by central government and deposit at banks.

We have adopted at present managed paper currency standard with a minimum reserve system of note issue in India.

The legal money, in which the government discharges its obligations , is known standard money.

India is on paper currency standard because India’s monetary authority, the Reserve Bank of India has adopted standard currency made of paper.

Paper currency in India is unlimited legal tender.

It means that it can be used to make payments and settle debts upto an unlimited amount.

Money Supply means the total amount of money available in the economy.

In other words, money supply refers to the volume of money held by the people in the country for transactions or for settlement of debts.

Central Bank

Commercial bank

Government

Volume of Trade

Balance of Payment

Price Level

Distribution of National Income

Banking Habits of people

The Result is: Money comes to RBI / Govt. - Less

money in the Market If People cannot borrow much they

have less Money

The Result is: People’s money gets invested in the

securities Commercial Banks will Lend lesser

money

Central Bank can:

Sell securities in the Market OR Increase the bank rate / Margin requirements/ CRR, etc

The Result is: Money flows from RBI / Govt. – more

money in the Market If People can borrow more they have

more Money

The Result is: People sell securities with them and

now have more money Commercial Banks will Lend more

money

Central Bank can:

Purchase securities in the Market OR Decrease the bank rate / Margin requirements/ CRR, etc

If People have a habit to save

Commercial Banks have more money to

lend

Hence, Money supply in the

economy would increase.

Volume of Trade

• Larger the volume of trade, larger the money flow

• i.e. more purchase and sale means money is changing hands more number of times.

Price Level

• The General Price Level will also affect the volume of trade.

• If necessities are expensive, people spend larger portion of income.

• Therefore, less savings by them.

Distribution of National Income

• If there is unequal distribution of National Income:

• Most of the population is poor and money gets accumulated in very few hands which will restrict the money flow.

In 1979 the RBI classified Money Stock in India in following 4 categories:

M1 = Currency with the public

(Coins + Currency notes + Demand deposits of the public) Also known as Narrow Money.

M2 = M1 + Post office savings

M3 = M1 + Time Deposits of the public with banks

(Also called Broad Money)

M4 = M3 + Total post office deposits.

The basic distinction between Narrow Money (M1) and Broad Money (M3) is the treatment of time deposits with the banks. In the present context, total Money Stock in India refers to M3 only.

The RBI working group has now redefined its parameters for measuring money supply. i.e.

New Monetary Measures.

NM1 = Currency + Demand Deposits + other deposits with RBI.

NM2 = NM1 + Time Liabilities portion of saving deposits with banks + Certificates of deposits Issued by banks + Term deposits maturing within a year excluding FCNR deposits.

NM3 = NM2 + Term deposits maturing within a year + call/term borrowings of the banking system.

M4 has been excluded from the new monetary aggregates.

MCQs

a. Lack of common measure of value.

b. Lack of double coincidence of wants.

c. Difficulty in storage of extra goods.

d. All of the above.

Answer: D Explanation: Refer

Slide No.4

a. Medium of exchange

b. Measure of value

c. Standard of deferred payments

d. All of the above

Answer: D Explanation: All the

Options refer to some function of Money and money is also defined as “Money is what money does”.

a. Medium of exchange

b. Measure of value

c. Standard of deferred payments

d. All of the above

Answer: A Explanation: Money as a

medium of exchange is used in the sale and purchase of goods and services. Therefore, double coincidence of wants is not required.

a. Paper

b. Metal

c. Foreign

d. Dollar

Answer: A Explanation: Refer

Slide No.20

a. Rs 5 note

b. Rs 10 note

c. Rs 1 note

d. None of the above

Answer: C Explanation: Rupee 1

Notes and Coins are issued by the Ministry of Finance.

a. Balanced

b. Maximum

c. Minimum

d. Neutral

Answer: C Explanation: Refer

Slide No.20

a. Stock of money held by public at a point of time in an economy.

b. Flow of money held by public at a point of time in an economy.

c. Flow of money held by government at a point of time in an economy.

d. Stock of money held by government at a point of time in an economy.

Answer: A Explanation: Refer Slide No.21

a. Currency

b. Deposit

c. Both currency and deposit

d. None of the above

Answer: C Explanation: Refer Slide No. 27

a. M1

b. M2

c. M3

d. M4

Answer: A Explanation: Refer Slide No. 27

a. M1

b. M2

c. M3

d. M4

Answer: C Explanation: Since M3 also includes Time Deposits with the banks, it indicates the store of value function of money.

a. M1

b. M2

c. M3

d. M4

Answer: A Explanation: Refer Slide No. 27

a. M1

b. M2

c. M3

d. M4

Answer: C Explanation: Refer Slide No. 27

a. NM1

b. NM2

c. NM3

d. NM4

Answer: C Explanation: Refer Slide No. 29

a. Treatment of Post office Deposits

b. Treatment of Time Deposits of Banks

c. Treatment of Savings Deposits of Banks

d. Treatment of Currency

Answer: B Explanation: Refer Slide No. 28

a. There are many assets which carry the attributes of Money

b. Money is what Money does

c. In modern sense, Money has stability substitutability & feasibility of measuring statistical variations

d. None of the above

Answer: D Explanation: Refer Slide No. 8