CBSE Class 12 Economics Money And Banking VBQs Set 03

MONEY AND BANKING

• Barter System of Exchange
• Concept of Money
• Supply of Money
• Commercial Banks
• Central Bank

POWER POINTS

1. Barter System of Exchange

Barter system of exchange is a system in which goods are exchanged for goods. Money as a medium of exchange does not exist.

Principal Drawbacks of the Barter System:

(i) It requires double coincidence of wants: Between two individuals, each one wants to buy that commodity which the other wants to sell. So that, each individual sells one commodity and buys the other at the same time.

(ii) It lacks common unit of exchange.

2. Concept of Money

Definition

Anything which is commonly accepted as a medium of exchange (like notes and coins) is called money.

Overtime, functions of money have expanded. Besides serving as a medium of exchange, money is used as a store of value (for savings) as well as for transfer of value. Accordingly, some economists define money in these words "Money is what money does". It refers to all functions of money. However, restricting ourselves to the limits of the syllabus, we are not discussing functions of money in detail other than noting the commonly known facts that money serves as a medium of exchange, a store of value, a unit of value (all prices are expressed in terms of money), and a means of transfer of value (transfer of funds from one place to the other).

Types/Forms of Money

(i) Fiat Money: It is the money issued by order of the government (notes and coins in circulation).

(ii) Fiduciary Money: It is the money backed with mutual trust between the payer and the payee (cheques and drafts).

(iii) Full Bodied Money: It refers to money in terms of coins whose commodity value is equal to the money value as and when these are issued.

(iv) Credit Money: It is the money of which money value is more than commodity value.

3. Supply of Money

It is a stock concept. It refers to total currency and notes with the people as well as demand deposits of the commercial banks at a point of time. It may be noted that while estimating total money supply we include all such financial instruments which act as money.

Supply of Money = Currency held by the People + Net Demand Deposits held by Commercial Banks

4. Commercial Banks

These are those financial institutions which accept deposits from the people and make advances.

Primary Functions of Commercial Banks are:

(i) Accepting deposits, and (ii) Advancing loans.

Money/Credit Creation by Commercial Banks

Commercial banks create money on the basis of their cash reserves. Money created is many times more than the cash reserves of the commercial banks.

This is also called credit creation by the commercial banks. It depend on CRR (Cash Reserve Ratio) as fixed by the central bank of the country (like Reserve Bank of India). Higher the CRR, lower the credit creation and vice versa.

Credit Multiplier

Credit multiplier is the reciprocal of CRR. It shows the number of times cash reserves of the commercial banks (with RBI) multiply to be equal to demand deposits.

\[ k = \frac{1}{CRR} \]

(Here, k = Credit multiplier; CRR = Cash reserve ratio: a percentage of demand deposits of the commercial banks to be kept with RBI as cash reserves.)

Thus, if CRR = 5%, Credit multiplier = \( \frac{1}{5\%} = 20 \).

Likewise, if CRR = 10%, Credit multiplier = \( \frac{1}{10\%} = 10 \).

[Note: Credit multiplier reflects the maximum amount of credit that the commercial banks can legally create on the basis of CRR (also called legal reserve ratio).]

5. Central Bank

Central bank is an apex banking institution which controls and manages the entire banking system in the country. It is a bank of all the banks as well as a bank of the government.

Functions of Central Bank:

(i) Issuing of notes, (ii) Banker to the government, (iii) Banker's bank, (iv) Lender of the last resort, (v) Custodian of foreign exchange, (vi) Clearing house function, and (vii) Control of credit.

'Control of Credit' Function of the Central Bank

The central bank controls the creation of credit by the commercial banks by exercising its monetary policy.

Instruments of monetary policy are broadly classified as:

(A) Quantitative Instruments: (i) Repo rate, (ii) Bank rate, (iii) Reverse repo rate, (iv) Open market operations, (v) CRR (Cash Reserve Ratio), and (vi) SLR (Statutory Liquidity Ratio).

(B) Qualitative Instruments: (i) Margin requirement, (ii) Rationing of credit, and (iii) Moral suasion.

QUESTION-ANSWERS

BARTER SYSTEM OF EXCHANGE

1. Objective Type Questions

A. Multiple Choice Questions

Question. A system in which commodities are exchanged for commodities is called:
(a) barter system of exchange
(b) monetary system of exchange
(c) commodity for commodity exchange economy
(d) both (a) and (c)
Answer: (d) both (a) and (c)

Question. Which of the following is the basic characteristic of the barter system of exchange?
(a) Medium of exchange
(b) Double coincidence of wants
(c) Store of value
(d) Both (a) and (c)
Answer: (b) Double coincidence of wants

Question. C-C economy refers to that system where:
(a) goods are exchanged for goods
(b) goods are exchanged for domestic currency
(c) goods are exchanged for foreign currency
(d) goods are not exchanged at all
Answer: (a) goods are exchanged for goods

B. Fill in the Blanks

Question. In _______, goods are exchanged for goods. (barter system of exchange/monetary system of exchange)
Answer: barter system of exchange

Question. C-C economy is dominated by _______ system of exchange. (barter/monetary)
Answer: barter

C. True or False

Question. There is no difficulty of double coincidence of wants in barter system.
Answer: False

Question. In the C-C economy, saving is possible only by way of storage of goods.
Answer: True

D. Very Short Answer Questions

Question. Define barter system of exchange.
Answer: Barter system of exchange is the system in which goods are exchanged for goods.

Question. What do you understand by double coincidence of wants?
Answer: Double coincidence of wants means that (at a point of time), the two individuals are in possession of such goods which they are willing to exchange for the satisfaction of their wants.

2. Reason-based Questions 

Question. Under barter system of exchange, goods are exchanged for goods.
Answer: True. Barter system of exchange is a system in which goods are exchanged for goods.

Question. A common medium of exchange exists in the C-C economy.
Answer: False. A common medium of exchange does not exist in the C-C economy. It is an economy where goods are exchanged for goods.

Question. Double coincidence of wants is the principal feature of the barter system of exchange.
Answer: True. Double coincidence of wants is the principal feature of the barter system of exchange. This arises because goods are exchanged for goods, and there is no common medium of exchange like money.

Question. In the C-C economy, saving is ruled out because there is no money in this economy.
Answer: False. Saving is not ruled out in the C-C economy. Saving is possible by way of storage of goods.

Question. Amisha buys an ice cream from a grocery shop for Rs. 20 and at the same time sells the packaging material to the grocery shop for Rs. 200. The sale and purchase by Amisha refer to barter system of exchange as it involves double coincidence of wants.
Answer: False. Sale and purchase by Amisha does not refer to barter system of exchange. Because, both sale and purchase are done using money as a common medium of exchange.

CONCEPT OF MONEY

1. Objective Type Questions

A. Multiple Choice Questions

Question. Money is:
(a) anything which requires double coincidence of wants
(b) anything which is commonly accepted as a medium of exchange
(c) anything which is commonly accepted as a commodity money
(d) none of the options
Answer: (b) anything which is commonly accepted as a medium of exchange

Question. Evolution of money has facilitated:
(a) a common unit of exchange
(b) store of value
(c) transfer of value
(d) All of the options
Answer: (d) All of the options

Question. With the introduction of money:
(a) acts of sale and purchase have been separated
(b) acts of exchange have been separated
(c) acts of production and consumption have been separated
(d) both (b) and (c)
Answer: (a) acts of sale and purchase have been separated

Question. Money which is accepted as a medium of exchange because of the trust between the payer and the payee is called:
(a) full bodied money
(b) credit money
(c) fiat money
(d) fiduciary money
Answer: (d) fiduciary money

Question. Money that is issued by the authority of the government is called:
(a) full bodied money
(b) credit money
(c) fiat money
(d) fiduciary money
Answer: (c) fiat money

Question. Money value is equal to commodity value in case of:
(a) fiat money
(b) full bodied money
(c) fiduciary money
(d) credit money
Answer: (b) full bodied money

Question. Electronic transfer of money in terms of credit/debit entries of the account-holders in the banks is called:
(a) e-marketing
(b) e-business
(c) e-money
(d) e-banking
Answer: (c) e-money

Question. In case of credit money:
(a) money value = commodity value
(b) money value > commodity value
(c) money value < commodity value
(d) none of the options
Answer: (b) money value > commodity value

Question. e-money functions as a medium of exchange by way of:
(a) transfer of value from one account to the other
(b) cash payments
(c) payments through cheques
(d) All of the options
Answer: (a) transfer of value from one account to the other

Question. Money is a:
(a) static factor
(b) dynamic factor
(c) contingent factor
(d) All of the options
Answer: (b) dynamic factor

B. Fill in the Blanks

Question. Money was evolved in order to remove the drawbacks of _______ system. (barter/monetary)
Answer: barter

Question. Anything can be money which is generally accepted as _______. (medium of exchange/medium of store)
Answer: medium of exchange

Question. _______ money is issued by order of the government. (Fiat/Fiduciary)
Answer: Fiat

Question. Credit money is that money whose money value is _______ than its commodity value. (more/less)
Answer: more

C. True or False

Question. Full-bodied money is that money whose money value is equal to its commodity value.
Answer: True

Question. Cheques are fiduciary money.
Answer: True

Question. Money value of a paper note is what is written on it.
Answer: True

D. Very Short Answer Questions

Question. What is meant by money?
Answer: Money can be defined as something that is generally accepted as a means of exchange and acts as a measure and as a store of value.

Question. Define fiat money.
Answer: Fiat money is the money issued by order of the government.

Question. Define fiduciary money.
Answer: Fiduciary money is the money backed with mutual trust between the payer and the payee.

Question. What is full bodied money?
Answer: Full bodied money refers to money in terms of coins whose commodity value is equal to the money value as and when these are issued.

Question. What is credit money?
Answer: Credit money is the money of which money value is more than commodity value.

Question. Define bank money.
Answer: Bank money is the money created by the bank in the form of demand deposits, over and above cash deposits of the people with the banks. It is a credit money and not a legal tender.

2. Reason-based Questions 

Question. Money is what money does.
Answer: True. Basically, money facilitates exchange of goods and services. Accordingly, money is defined as 'anything that acts as a medium of exchange'.

Question. Introduction of money has removed the major drawback of double coincidence of wants in the barter system of exchange.
Answer: True. Use of money as a medium of exchange has removed the major drawback of double coincidence of wants in the barter system of exchange. With the introduction of money, acts of sale and purchase have been separated.

Question. Fiat money is that money which is accepted as a medium of exchange because of the trust between the payer and the payee.
Answer: False. Fiat money is that money which is issued by order/authority of the government.

Question. Cheques are fiat money.
Answer: False. Cheques are fiduciary money because these are accepted as a means of payment on the basis of trust, not on the basis of any order of the government.

Question. Commodity value of a ten rupee coin in India is more than its money value.
Answer: False. Commodity value of a ten rupee coin in India is definitely less than its money value. Otherwise, people would have melted the coins and sold them as a commodity.

Question. Money value of a Thousand rupee note is what is written on it.
Answer: True. Money value of money is the value which is inscribed on a coin or written on a paper note. Thus, money value of a Thousand rupee note is what is written on it.

Question. Money is a dynamic factor.
Answer: True. Money is a dynamic factor because it has imparted dynamism to the process of production, consumption, investment and exchange.

Question. Money has facilitated the sale and purchase of goods and services.
Answer: True. Money has facilitated the sale and purchase of goods and services. With the use of money as a medium of exchange, goods and services can be purchased for money any time. Similarly, goods and services can be sold for money any time.

Question. Measurement of value was very difficult in the barter system of exchange.
Answer: True. Measurement of value was very difficult in the barter system of exchange because there was no common unit of value.

Question. Emergence of financial market increases the consumption and investment expenditure in the economy.
Answer: True. Financial market offers funds for investment as well as the purchase of consumer durables. Availability of funds through financial market has led to a multiple increase in consumption expenditure as well as investment expenditure.