AL-AMEEN COLLEGE OF LAW

MODEL ANSWER PAPER – MAY – 2016

ECONOMICS
MONEY BANKING AND INTERNATIONAL TRADE

Q.No.1. Define Money. Explain the functions of money.

Ans: Money has been defined differently by different economists. According to F.A.Walker,
“Money is what money does.”.
According to Robertson, “Money is anything which is widely accepted in payment for
goods or in discharged of other kinds of business obligations.”
Money performs many functions.
1. Primary Functions
2. Secondary Functions
3. Contingent Functions
4. Other Functions

1. Primary Functions:
a) A Medium of Exchange: The most important function of money that, it serves as a
medium of exchange. It facilitates exchange through a common medium i.e. currency.
This function of money has eliminated the problem of the lack of double coincidence of
wants which was the main difficulty under barter system.
b) Measures of Value: Money serves as a common unit of value. The value of goods and
services can be expressed in terms of money. Money has provided a common yardstick to
measure the value of all commodities and services in a common unit known as price.

2. Secondary Functions:
a) Standard of deferred payments: Money can be used for future payments. Deferred
payment refers to the future payments and contractual payments such as loans and
interest payments, salaries, etc.
 b) Store of Value: Generally people have a tendency to save certain portion of their income
in the form of savings and to accumulate wealth. People save money to meet unforeseen
contingencies.
c) Transfer of Value: With the help of money values and wealth can be transferred from one
place to another. Similarly money can be transferred easily from one place to another and
one person to another. So purchasing power can be transferred.

3. Contingent Functions:
a) Distribution of National Income: Money facilitates the distribution of national income
among the four factors of production as a reward in the form of rent, wages, interest and
profit.
b) Basis of Credit: The modern economy is based on credit. Money serves as a basis of the
vast structure of modern credit system.
c) Liquidity and Uniformity: Money gives liquidity to various forms of wealth. That is
money is most liquid form of all the assets and wealth. Money can be converted into any
type of asset and asset can be converted into money.

4. Other Functions:
a) Helps in making decisions
b) Generalized purchasing power
c) Determination of solvency.

Q.No.2. What do you mean by Commercial Bank? Explain the functions of Commercial
Bank.
Ans: A bank is an institution which deals in money. It accepts deposits from the public and lends
the same to those who are in needs of it. It is a dealer in money and credit.
Crowther, defines a banking institution as “a dealer in debt his own and other people”.
Functions of Commercial Bank
I. Primary Functions
II. Secondary Functions
I. Primary Functions
a) Accepting Deposits: It is the most important function of commercial banks. They accept
several types of deposits from the public. They are:
1) Current Account Deposits: These deposits are payable on demand. Money from these
accounts can be withdrawn any number of times as desired by the depositors.
Normally, no interest is paid on these deposits. This is also called as Demand
Deposits.
2) Saving Account Deposits: People with low income, salary earners, etc. generally open
these accounts. Certain restrictions are imposed on these accounts regarding the
number of withdrawals. Money deposited in the account can be withdrawn either
once or twice a week. Rate of interest paid on these deposits is law.
3) Fixed Deposits: Money in these accounts is deposited for a fixed period time and
cannot be withdrawn before the maturity of that period. The rate of interest paid on
these deposits is higher than that, on the other deposits. Fixed deposits are also called
time deposits.
4) Recurring Deposits: Money in these accounts is deposited in monthly installments for
a period of one year or more. After the completion of the last installments the total
amount accumulated is paid to the depositor along with the interest.

b) Advancing of loans: Another important function of commercial bank is to advance loans

to the public. They are:
1) Over Draft: It is a facility provided by a bank to its current account holders. The bank
allows such customers to over draw their accounts upto certain limit.
2) Cash Credit: It is a type of loan which is given to the borrower against the current
assets, such as shares, stocks, bonds, etc. The bank opens the account in the name of
the borrowers and allows him to withdraw the money from time to time upto a certain
limit as determined by the value of his current assets.
3) Loans: Loan is a financial arrangement in which credit is provided by a commercial
bank through opening a separate account is called loan account. In this method the
bank gives a specified sum of money to a person or a firm against some collateral
 security. The loan amount is credited to the account of the borrower and the borrower
can withdraw money from the account according to his requirements.
4) Discounting of Bills of Exchange: This is another type of lending by the modern
banks. Discounting the bills of exchange means encashing the bills of exchange the
banks before the date of maturity.

II. Secondary Functions:

a) Agency Services
b) General Utility Services

a) Agency Services: Bank performs certain agency services for and on behalf of their
customer. They are
1. Remittance of funds
2. Collection and payment of credit instruments
3. Buying and selling of securities
4. Collection of dividends
5. Making of payments
6. Income tax consultancy
7. Acting as Trustee and Executor.

b) General Utility Services:

1. Locker facility
2. Issue of traveler’s cheques
3. Letter of credit
4. Underwriting of securities
5. ATM facility
6. Credit cash
Q.No.3. Explain briefly the functions of Central Bank.
Ans: The RBI performs all traditional developmental and other functions.
I. Traditional Functions:
a) Monopoly of Note Issue: Under section 22 of the RBI Act, the bank has the sole right
to issue of currency notes of all denominations of RS.10, 20, 50, 100, 500 and 1000 in
the country. RBI follows minimum reserve system while issuing notes since 1956. It
has to maintain reserve of gold, silver and foreign exchange against issue of currency
notes.
b) Banker to the Govt.: RBI act as a banker, agent and advisor to the Govt. The RBI
performs the same functions as the commercial banks perform to their customers,
such as it receives deposits from the Govt. and advances loans to it when it is in need.
c) Banker’s Bank: The activities of all commercial banks are controlled and managed by
the RBI. The regulation of banks may be related to their licensing, branch,
expansions, liquidity of assets, etc.
d) Lender of last resort: The RBI helps the commercial banks in times of their financial
crisis. When commercial banks are not able to get financial assistance from any
source RBI come to their rescue. That is why the commercial banks can approach the
RBI for loons.
e) Clearing house: The RBI acts as a clearing house for transfer and settlement of
mutual claims of the commercial banks. As it keeps the cash reserves of all
commercial banks, it is easy to settle each others debts or transfer of funds from one
bank to another.

II. Developmental Functions:

1. Agricultural Finance: The RBI has been extending advice and financial assistance to
the co-operative credit institutions for the development of agriculture. For this
purpose it has set-up an agricultural credit department.
2. Industrial Finance: The RBI provides credit facilities to both small scale and large
scale industries through State Finance Corporations (SFC). IFCI, IDBI, ICICI, etc. it
also established National Industrial Credit Fund in 1964 to provide financial
assistance.
 III. Other Functions:
a) Research functions
The RBI collects and publishes information relating to agricultural industrial,
financial sectors of the economy, exports and imports banking trends in money and
capital markets, price trends, etc. On the basis of these information the Govt. can
formulate and implements its economic and monetary policies. It also issues special
bulletins, Journals and various research papers.
b) Special functions: The RBI conducts special debates and seminars on various
subjects. It also provides training facilities to bank staff. It maintains regular contracts
with various international financial institutions. It also suggest remedies for the
problems of poverty, unemployment inflation, inflation, deflation, etc.

Q.No.4. Explain the importance of International Trade.

Ans: Benefits of International Trade.
1. International Division of Labour & specialization
The greater advantage or benefit of international trade is the division of labour and
specialization is the field of production and international exchange of commodities.
Adam Smith said, ‘the tailor does not attempt to make his own shoes, but buys them from
a shoe maker. The shoe maker does not attempt to make his own dress but employee a
tailor. A farmer does not attempt to make neither the one nor the other”. Thus every
individual and country tries to specialize in the production of those goods in which it
enjoys facilities and exchange the same with other countries as the native country will
have the advantage of production at the least cost.

2. Optimum use of world resources:

International trade promotes optimum use of the resources of the world. Each country
sells products where it can get higher prices and buys essential raw materials from those
market where these are the cheapest.
3. Stabilization of Prices:
In the absence of international trade, the domestic shortage leads to serious inflationary
trends. Similarly surplus may create deflation. Though international trade the effects of
inflation and deflation could be minimized.

4. Technological progress:
International trade promotes technological progress as it allows import of new machines.
Equipment, design and technical services from other countries.

5. Easy flow of capital:

International trade develops mutual relation among the countries and facilitates short
term and long term flow of capital. Infact many countries depends of foreign country in
the initial stages of their economic development.

6. Promotion of competitions:
International trade promotes competition among the different countries. International
competition brings efficiency. It become possible to impose quality products from other
countries at reasonable prices.

7. Greater-bi-lateral co-operation:
International trade develops mutual cooperation among the trading countries. The
countries co-operate among themselves to resolve their differences and problems through
bi-lateral agreements.

8. Growth of International economic institutions:

It has lead to the growth of several multi-lateral like IMF, IBRD, IDA, UNCTAD &
WTO.
 9. Expert Promotes Growth:
There are many countries such as Japan, France, U.K, USA and in recent year South
Korea, Taiwan, Malaysia, China and many gulf countries are promoting their economic
growth through exports. Infact their strategy is to maximize export to promote economic
growth.

Q.No.5. Explain briefly the objectives and functions of WTO.

Ans: The urgency round agreement of GATT provided for ht setting up of the World Trade
Organization. The WTO started functioning from January 1995. It has a watchdog of
international trade and its regularly examines the trade regimes of individual members.

The Objectives of WTO:

In its preamble, the agreement establishing the WTO lays down the following objectives;
1. Its relations in the field of trade and economic endeavour shall be conducted with a view
to raising standards of living ensuring full employment, expanding production and trade,
optimal use of world’s resources and expanding the production and trade in the goods and
services.
2. To allow for the optimal use of world’s resources in accordance with the objective of
sustainable development, seeking both a) to protect and preserve the environment and b)
to enhance the means for doing so in a manner consistent with respective needs and
concerns at different levels of economic development.
3. To make positive efforts designed to ensure that developing countries, especially the least
developed among them, secure a shave in the growth in international trade commensurate
with needs of their economic development.
4. To achieve these objectives by entering into reciprocal and mutually advantageous
arrangements directed towards substantial reduction of tariff and other barriers to trade
and the elimination of discriminatory treatment in international trade relations.
5. To develop an integrates, more viable and durable multilateral trading system
encompassing the GATT, the results of past trade liberalization efforts and all the results
of the Uruguay s round of multilateral trade negotiations and
 6. To ensure linkages between trade policies, environmental policies and sustainable
development.

Functions of the WTO

1. It facilitates the implementation administration and operation of the objective of the
agreement and of the multilateral trade agreement.
2. It provides the framework for the implementation administration and co-operation of the
plurilateral trade agreements relating to trade in civil craft, Govt. procurement trade in
dairy product and bovine meal.
3. It provides the forum for negotiations among its members concerning their multilateral
trade relations in matters dealt with under the agreement.
4. It administers the understanding on rules and procedures governing the settlement of
disputes of the agreement.
5. The WTO shall administer the trade review mechanism.
6. It co-operates with the IMF and the World Bank and its affiliated agencies with a view to
achieving greater coherence in global economic policy making.

Q.No.6. Define MNC. What are the advantage and disadvantages of MNCs?
Ans: MNC’s are huge firm which extend their industrial and marketing operation through a
network of their branches in other countries. MNCs have their headquarters located in one
country. i.e. developed countries and operates both in developed and developing countries.
According to J.H.Dunning, ‘MNC is any enterprises which owns and controls income
operating assets in more than one country’.

Advantages of MNCs
1. MNCs help a developing country by increasing investment, income and employment.
2. MNCs helps in promoting exports of the host country.
3. Entry of MNC in the host country makes its market more competitive and break the
domestic monopolies.
4. MNCs are regarded as agents of modernization and thereby developing the growth of the
economy rapidly.
 5. MNCs by producing certain required goods in the best country help reducing its
dependence on imports.
6. MNCs due to their wide network of productive activity equalize the cost of production in
global market.
7. MNCs are the vehicles of peace in the world, they help in developing cordial political
relationship among the countries of the world.
8. MNC’s integrates national and international markets.
At the ends of 1990 there were 469 foreign companies in India. At present there are 500
MNCs operating in India.

Disadvantages of MNCs.
1. MNCs are basically profit motivated and hence they are responsible for drain of
resources from the host country.
2. They produce inappropriate products those demanded by a small rich minority and
stimulate inappropriate consumption pattern through advertising.
3. There may be responsible for creation of monopolies in the market and eliminate local
competitors.
4. The domestic capital formation and investments of UDC’s is adversely affected on
account of investment by MNCs.
5. MNCs are responsible for creating social inequalities and also breeds discontent and
unrest among the workers employed in the local industries of host countries.
6. MNCs establish their venture in UDC’s and exploit cheat labour available there.
7. MNCs bring in their cultural norms of attitudes in the host country and may cause threat
to the original culture of the host country in various ways.
8. MNCs suppress the domestic entrepreneurship and hence small scale enterprises will be
whipped out completely.

Q.No.7. What is Inflation? Explain the causes and effects of Inflation.

Ans: Inflation is a global phenomenon. It is seen in every type of economy developed and under-
developed. It occurs not only in war time, but also in peace time. inflation is defined in different
ways by different writers.
 Johnson defines, “Inflation as sustained or persistent rise in prices”.
In the words of T.E.Gregory “Inflation is abnormal increase in quantity of money”.
Causes of Inflation
1. Increase in Money Supply: Expansion of the supply of money beyond the normal
requirements of trade and industry is one of the causes responsible for inflation. When
the supply of money increases price rise.
2. Wars: Wars are responsible for inflation. During wars, the needs of the military are
required to be met first consequently the supply of goods for the civilians is reduced. This
causes rise in prices.
3. Excessive investments by the Govt.: When the govt. of a country spends enormous
amount of money on project which will take a long time to yield results. There will be
rise in the income of the people without corresponding increase in the supply of goods.
Thus inturn causes the prices to go up.
4. Deficit Financing: Deficit financing by the govt. is one of the causes responsible for
inflation. When the govt. adopts deficit financing there results in printing of more
currency notes. The printing of more currency notes results in increase in the supply of
money and forces the prices to go up.
5. Taxes: Taxes like excise duties levied by the govt. will result in rise in prices.
6. Hoarding of goods: Hoarding of goods by producers and traders will create artificial
scarcity of goods. The artificial scarcity of goods will push up the prices.
7. Natural calamities: Natural calamities like floods, droughts, earthquakes, etc. will
adversely affect the normal productive activities in the country and cuase the scarcity of
certain product. Thus in turn gives rise to rise in prices.

Effects of Inflation:
1. Effects on Debtors: Inflation benefits the debtors in the sense that, when there is inflation the
debtors are actually paying back to the creditors less than what they have lent.
2. Effects on Creditors: The creditors lose during inflation as they get back from the debtors
less than what they have lent.
3. Effect on producers: The producers on goods benefit from inflation as they get higher prices
for their finished goods. No doubt, they may have to pay higher prices for the various factors
of production.
4. Effects on Farmers: Farmers gain from inflation in many ways. First they get higher prices
for their products especially for essential food stuffs. Secondly they can hoard farm products
and gain from speculative rise in prices.
5. Effects on Speculators: Inflation is beneficial to speculators. They can hoard stocks of goods,
create artificial scarcity of goods, cause rise in prices and gain from the rise in prices.
6. Effects on wage earners: Inflation is both advantageous and disadvantageous to the wage
earners. It is disadvantageous to them as the rise in their wages is less than the rise in prices.
7. Effects on fixed income groups: Fixed income groups are hit very hard by inflation, because
while their money incomes remain fixed, their real incomes fall on account of the fall in
value of money.

Q.No.8. Short Notes:

a) Comparative Cost Theory:
David Ricardo analysed the causes for and the benefits of international trade in tems of
comparative costs. David Ricardo agreed with the analysis of Adam Smith that, international
trade would be mutually advantageous in one county has absolute advantage over another
country in one commodity and the other country has an absolute over the first country in another
commodity.
He went further and pointed out that any two countries could very well gain by trading
even if one of the countries is having an absolute advantage in both the products over the other
country, provided the extent of absolute advantage is different in the two commodities in
question i.e. the comparative advantage is greater in respect of one commodity than in respect of
the other commodity. In the given example, the opportunity cost of product X and product Y in
county A and country B will be as follows:
Country A Country B
Product X 5/10 = 0.5 20/15 = 1.33

Product Y 10/2 = 2 15/20 = 0.75

 From the opportunity cost of the products it is clear that country A has comparative
advantage in producing product X and country B has comparative advantage in producing
product Y. so, county A can specialize in the production of product X and the country B can
specialize in the production of product Y and can gain from trading.

b) Supply of money:
Money supply refers to the total stock of money of various kinds in existence at any
particular point of time. There are two important points about money supply they are (1) money
supply is a stock concept. i.e. it is the stock of money and (2) it is the stock of money with the
public.
Since April 1977RBI has adopted four concepts of money supply i.e. M1, M2, M3 and M4
1. M1 = It includes currency with public demand deposits and other deposits with RBI. It is
termed as narrow money. It is measured as follows:
M1 = C+DD+OD
Where, C = Represents currency with public DD represents demand deposits with
commercial banks.
OD = Represents other deposits with RBI

2. M2 = It includes all components of M1 and savings deposits with post office. It is measured as
follows:
M2 = M1 + POSBD
Where, M2 = Savings deposits.
M1 = is C+DD+OD
POSBD = Represents post office savings deposits.

3. M3 = It includes all the components of M 1 along with time deposits of all banks. It is a broad
money concept. It is measured as follows:
M3 = M1 + TD
Where TD = represents time deposits with all banks.
4. M4 = It includes all the components of M3 and total deposits with post office savings deposits
(excluding National Savings Certificates) it is measure as follows:
M4 = M3 + TOPD
Where TOPD = represents total post office deposits (excluding NSC)

c) Balance sheet of Commercial Bank

Illustration:
1. There are several banks says, A B C etc.
2. Every bank has to keep 10% of cash reserve
3. A new deposit of Rs.1000 has made by a customer in bank A.
4. The people have banking habits.
5. The loan amount drawn by the customer of first bank is deposited in full in the second bank
and that of the second bank in the third bank and so on. Given these assumptions suppose
bank A receivers cash deposits of Rs.1000 from a customer, given the reserve ratio of 10%
the bank keeps Rs.100 (10% of 1000) in reserve and lends Rs.900 to Mr X.
The balance sheet of bank A is as follows:
Liabilities Assets
Deposits – Rs.1000 Cash reserve Rs.100
Loan to Mr X Rs.900
Total – Rs.1000 Total Rs.1000

When Rs.900 is lent by bank A to Mr.X who either deposits it with same bank or with the
other bank. Suppose the loan of Rs.900 is deposited by Mr.X in Bank B, Bank B starts with a
deposits of Rs.900, keeps 10% of it or Rs.90 as cash reserve and lends Rs.810 to Mr.Y. Then the
balance sheet of the bank B is as follows:
Liabilities Assets
Deposits – Rs.900 Cash reserve Rs.90
Loan to Mr Y Rs.810
Total – Rs.9000 Total Rs.900

This loan of Rs.810 is deposited by Mr.Y in bank C, Bank C keeps 10% or Rs.81 of
Rs.810 as cash reserve and lends Rs.729 to Mr.Z. then the balance sheet of bank c is as follows:
 Liabilities Assets
Deposits – Rs.810 Cash reserve Rs.81
Loan to Mr X Rs.729
Total – Rs.810 Total Rs.810

Thus the process will continue till the cash deposit of Rs.1000 is completely used. The
cash deposit of Rs.1000 led to a loan deposit of Rs.900+810+729 and so on. Now the total
deposits of all the banks shall be Rs.10,000/-
Multiple credit creation (Amount in Rs.)
Banks Liabilities Cash reserve New loan
Bank A 1000 100 900
Bank B 900 90 810
Bank C 810 81 729
All other banks 7290 729 6561
Total for whole 10000 1000 9000
banking system

Q.No.9.
a) Explain the Monetary Policy of RBI.
Ans: The method adopted by the RBI to regulate and control money circulation or supply of
money in the country is known as monetary policy of RBI. It is grouped under two heads;
a) Quantitative methods b) Qualitative methods
a) Quantitative Methods:
1. Bank Rate: It is the rate of interest charged by the RBI for providing fund or loans to the
banking system. This is also known as the discount rate banking system includes commercial
and co-operative banks, industrial development bank of India (IDBI), Industrial Finance
Corporation, etc. are approved financial institutions.
2. Open Market Operations: It is an instrument of monetary policy which involves buying and
selling of govt. securities in open market.
3. Cash Reserve Ratio: It is a certain percentage of bank deposits which commercial banks are
required to keep with the RBI in the form of reserve or balance.
4. Statutory Liquidity Ratio: In addition to CRR, the RBI direct to commercial banks have to
maintain a certain percentage of their total demand and time deposits with themselves in the
form of liquid assets.
b) Quantitative Methods:
1. Margin Requirement: Loans are granted by commercial banks against the securities. The
amount lent by the banks is a fraction of the market value of the security. A central bank
varies the margin requirement from time to time to regular the volume of the credit.
2. Regulation of Consumer Credit: Credit given consumers to buy certain durable goods like
cars, televisions washing machine furniture etc. is called consumer credit.
3. Control through Directives: The central bank may enforce the written or oral directives in
desired direction to the commercial banks.
4. Credit Rationing: The RBI issues prior information or direction that loans to the commercial
banks will be given to a certain limit.
Direct action moral suasion and publicity are other measures of qualitative method.

b) Write a note on Quotas.

Ans: Import quota is a protectionist device to restrict the supply of a good or service from
abroad. Under an import quota a fixed amount of a commodity in volume or value is allowed to
be imported into the country during a specified period of time, usually a year. For this purpose
the govt. may issue an import license that it may sell either to importers at a competitive price or
just give importers on the basis of first come first served. They are also used as a retaliatory
device.
Import quotas are of five types.
1. Unilateral Quotas: Under this system, the total value of the commodity to be imported is
fixed by law or degree without any agreement with other countries. The autonomously fixed
quota may be either global or allocated under the global quotas, the full amount of the quotas
may be imported from any one country.
2. Tariff Quotas: Under this system a given quantity of good is permitted to enter duty free or
upon payment of relatively low duty. But imports in excess of that quantity are charged a
relatively high rate of duty.
3. Bi-lateral Quotas: Under this system quotas are fixed by some agreement with one or more
other countries. Heberler calls them agreed quotas.
4. Mixing Quotas: This system requires domestic producers in the quota fixing country to use
imported raw materials in certain proportion along with domestic raw material to produce
finished products. Thus the quotas imported are fixed by the govt.
5. Import Licensing: It is the system devised to administer the various types of quotas.
According to this system, the amount of the commodity to be imported is first determined on
the basis of the above mentioned quota systems.

c) What is BOP? Explain the cause of disequilibrium in BOP.

Ans: Balance of payment is a comprehensive term where as balance of trade is a narrow concept.
Balance of payments refers to both visible and invisible items of trade. Visible items
refers to the goods or merchandise items. Invisible items refer to the services that enter into
trade.
Balance of payment according to IMF “as a systematic record of all economic
transactions during the period generally one year between residence of the reporting countries.

Causes of Disequilibrium
1. Temporary Changes or Disequilibrium: There may be temporary disequilibrium cuased by
random variations in trade. Seasonal fluctuations the effects of weather on agricultural
production etc.
2. Fundamental Disequilibrium: It refers to a persistence and long term equilibrium in the BOP
of a country. It is chronic BOP deficit. According to IMF it is caused by such factors as
a) Changes in consumers tastes within the country or abroad which reduce the country’s
exports and increase imports.
b) Continuous fall in the foreign exchange reserve of a country
c) Excessive capital outflows due to massive imports of capital goods.
d) Low competitive strength in the world market which affects exports.

3. Changes in exchange Rate: Changes in foreign exchange rate in the form of over valuation
or under valuation of foreign country leads to BOP disequilibrium.
4. Cyclical fluctuation: Cyclical fluctuation in business activity also lend to BOP
disequilibrium. When there is depression in a country, volume of both exports and imports
fall drastically in relation to other country.
5. Changes in National Income: If the national income of a country increases it will lend to an
increase in imports there by creating a deficit. In the same manner an increase in national
income means expansion of exports.