Ch 03 – Money and Banking – Key Revision Notes Latest

Ch 03 – Money and Banking – Key Revision Notes” provides concise, exam-focused revision notes for Class 12 Economics students studying Chapter 3, Money and Banking. Covering essential topics like the functions of money, money supply, the role of commercial banks, and RBI’s monetary policy instruments, this guide is tailored to help students grasp core concepts quickly and effectively, ideal for last-minute exam prep. Perfect for CSS XII students aiming to solidify their understanding and ace their economics exams!

Introduction to Money (Ch 3 – Money and Banking)

• Money: Commonly accepted medium of exchange in an economy, replacing the need for a barter system, which requires a double coincidence of wants (e.g., one person’s rice for another’s clothing).

3.1 Functions of Money (Ch 3 – Money and Banking)

• Medium of Exchange: Money simplifies transactions, replacing complex barter trades.
• Unit of Account: Allows valuation of goods/services in monetary terms (e.g., if a pen costs Rs 10, it’s worth five pencils priced at Rs 2 each).
• Store of Value: Money can hold purchasing power over time if stable; perishable goods cannot.
• Standard of Deferred Payment: Used to settle debts and plan future payments.

3.2 Demand for Money and Supply of Money

• Demand for Money: Driven by transactions and speculative motives.
  • Transactions Motive: Money is required to buy goods and services, related to income levels.
  • Speculative Motive: Desire to hold money instead of assets like bonds, influenced by interest rates.
• Supply of Money: Comprises currency and bank deposits, regulated by the central bank and commercial banks.

3.2.2 Supply of Money Components (Ch 3 – Money and Banking)

• Central Bank: Issues currency and controls the money supply (e.g., India’s Reserve Bank).
• Commercial Banks: Accept deposits, lend to borrowers, and create money by lending a portion of deposits.

3.3 Money Creation by Banking System

• Credit Creation: Banks lend part of deposits, creating more money in the economy.
  • Example: If the Reserve Ratio (CRR) is 20%, banks keep 20% of deposits as reserves and lend the rest.
• Money Multiplier: Total money created from each deposit; formula: .

3.4 Policy Tools to Control Money Supply

• Quantitative Tools: Influence the amount of money, like CRR and Open Market Operations.
• Qualitative Tools: Aim to direct lending practices, using tools like moral suasion.
  • Open Market Operations: Central bank buys/sells government bonds to adjust money in circulation.
  • Repo and Reverse Repo Rates: Interest rates in short-term lending, influencing money supply.

Legal Definitions of Money

• Fiat Money: Currency issued by government decree, without intrinsic value (e.g., currency notes).
• Legal Tender: Must be accepted for payments, unlike cheques.

Types of Money Supply Measures

• Narrow Money (M1): Most liquid, including currency and demand deposits.
• Broad Money (M3): Includes M1 and time deposits, used to assess overall money supply in India.

Box 3.2: Demonetisation in India

• Demonetisation (2016): Government invalidated Rs 500 and Rs 1000 notes to curb corruption and black money.
• Impact: Initial disruptions but improved tax compliance and shifted transactions to digital payments.

Summary

Money facilitates exchange, is universally accepted, and serves as a measure of value, a store of wealth, and a medium for deferred payments. In modern economies, central and commercial banks play crucial roles in money creation and regulation, affecting economic stability through policies like the CRR, bank rate, and open market operations.

Question Answer of Money and Banking

1. What is a barter system? What are its drawbacks?
   • Answer Type: Very Short Answer
   • Answer: A barter system is an exchange method where goods or services are directly traded without money. Its drawback is the “double coincidence of wants,” making it difficult to find a mutual exchange.
2. What are the main functions of money? How does money overcome the shortcomings of a barter system?
   • Answer Type: Short Answer
   • Answer: Money serves as a medium of exchange, a unit of account, a store of value, and a standard for deferred payments. Unlike barter, money eliminates the need for a double coincidence of wants, simplifying transactions and enabling easier storage of wealth over time.
3. What is transaction demand for money? How is it related to the value of transactions over a specified period of time?
   • Answer Type: Short Answer
   • Answer: Transaction demand for money refers to the amount of money people hold for everyday transactions. It is directly proportional to the total value of transactions in an economy over time, as higher transaction volumes increase the need for accessible funds.
4. What are the alternative definitions of money supply in India?
   • Answer Type: Very Short Answer
   • Answer: In India, the money supply is defined by M1, M2, M3, and M4, with M1 and M2 as narrow money and M3 and M4 as broad money, based on decreasing liquidity.
5. What is a ‘legal tender’? What is ‘fiat money’?
   • Answer Type: Short Answer
   • Answer: Legal tender is currency that must be accepted for transactions by law. Fiat money is currency without intrinsic value but holds value because the government issues and backs it.
6. What is High Powered Money?
   • Answer Type: Very Short Answer
   • Answer: High Powered Money, or reserve money, includes currency issued by the central bank, held by the public and commercial banks, forming the base for money creation in the economy.
7. Explain the functions of a commercial bank.
   • Answer Type: Long Answer
   • Answer: Commercial banks perform several essential functions. They accept deposits from the public, provide loans to individuals and businesses, facilitate payments through checks and transfers, and offer various financial services. By holding deposits and issuing loans, they contribute to the economy’s money supply. Banks also play a critical role in implementing monetary policy by adjusting interest rates and managing credit based on central bank regulations.
8. What is money multiplier? What determines the value of this multiplier?
   • Answer Type: Short Answer
   • Answer: The money multiplier shows the extent of money creation by commercial banks from an initial deposit. It depends on the reserve ratio; a lower reserve ratio results in a higher multiplier effect as banks can lend more.
9. What are the instruments of monetary policy of RBI?
   • Answer Type: Short Answer
   • Answer: RBI uses quantitative tools like the Cash Reserve Ratio (CRR), bank rate, and open market operations, along with qualitative tools like moral suasion and margin requirements to control the money supply.
10. Do you consider a commercial bank ‘creator of money’ in the economy?
    • Answer Type: Short Answer
    • Answer: Yes, commercial banks create money through credit creation. By lending a part of deposited funds, they generate more deposits, expanding the money supply in the economy.
11. What role of RBI is known as ‘lender of last resort’?
    • Answer Type: Very Short Answer
    • Answer: RBI acts as the “lender of last resort” by providing funds to commercial banks when they face a liquidity crisis, ensuring financial stability.