Money and Banking

What do you mean by money?

[2]
Anything that is generally accepted as a means of exchange and at
the same time acts as a measure and store of value can be considered
as money.
Types/Kinds of money [2 marks
each]
➢ Token Money
If the face value of money exceeds its intrinsic (metallic) value, it
is called token money. Example token coins are made of cheap
metals like nickel, copper, bronze.
➢ Fiat Money
When the value of currency notes and coins is derived from the
guarantee provided by the issuing authority (say, RBI), then these
currency notes and coins are called ‘fiat’ money.
➢ Currency notes
Currency notes refer to paper money Example: 10, 20, 50, 100,
200, 500, 2000 rupee notes. Currency notes have a very small
intrinsic value of their own. In India, virtually all paper money is
issued by the RBI which is the central bank of the country.
➢ Deposit Money or Bank Money
It refers to the demand deposits held by the public with
commercial banks on the basis of which cheques can be drawn. It
must be remembered that deposit money or bank money is not
➢legal tender.
It is, however, a convenient and safe device of making payments
for trade and other business transactions. Legal Tender When the
currency notes and coins of a country cannot be refused by its
citizens for the settlement of any kind of transaction, then these
currency notes and coins are called legal tender.
• Limited Legal Tender
2 Coins of smaller denomination may be accepted by the citizens
only to settle claims of limited value. Hence they are called limited
legal tender.
• Unlimited Legal Tender
Coins and currency notes of higher denominations are accepted by
all citizens for settling claims of any value without limit. Hence
they are called unlimited legal tender.
3. Explain the primary functions of money
[3]
- Medium of Exchange
The most important function of money is to facilitate the process
of exchange. Money commands a general purchasing power to
purchase any kind of goods and services. The use of money as a
common medium of exchange has facilitated the exchange greatly.
It has removed the inconveniences of double coincidence of wants
prevalent in the barter system. Moreover, it has increased
efficiency in production by making it possible to exploit the
benefits of division of labour.
- Measure of Value or Unit of Account
Money acts as a common measure of value or unit of account.
Since, price is the value of a commodity expressed in terms of
money, it has become easy to determine the rate of exchange
between any two commodities. For example, if the price of a book
is Rs.100 and the price of a pencil box is Rs.25, then a book can be
exchanged for 4 pencil boxes. The use of money has simplified the
complex calculations that existed in the barter system.
4. What are the secondary functions of money?
[3/6]
- Store of Value
Wealth is usually kept in the form of money because it is the most
liquid form of wealth. During barter system, storing was difficult
particularly for perishable commodities. Money has proved to the
most economical and convenient of storing wealth. Further, storing
money means holding of general purchasing power which can be
used at any point of time to purchase goods and services.
- Standard of Deferred Payment
Acting as a standard of deferred payment means that a payment to
be made in the future can be stated in terms of money. In a modern
economy, a large number of transactions like interest, rent pension,
loans etc involve future payments expressed in terms of money.
Credit is required when we want to consume now and pay later.
Since money has general acceptability for future payments, it is
called the standard of deferred payments.
- Transfer of Value
Money also serves as a means to transfer value from one
individual to another. For example, when a person purchases a pen
for Rs.20, the value of the commodity can easily be transferred
from the buyer to the seller through a payment in terms of money.
We can also sell a house in Delhi in exchange of money and use
the money to buy another house in Kolkata.
5. Explain the contingent functions of money.
[3/6] - Maximisation of Utility
The principal objective of a consumer is to maximise his total
utility through the consumption of various goods and services. He
will be able to do that when the ratios of marginal utilities of
different goods and services are equal to the price ratio of those
commodities. Money, thus, plays an important role as prices are
expressed in terms of money.
- Employment of Factor Inputs
The principal objective of a producer is to maximise his profits. A
profit maximising producer will equate the marginal productivity
of a factor with its price (remuneration). Since factor payments are
made in terms of money, it plays an important role in taking
production decisions regarding employment of factors.
- Distribution of National Income
The owners of the factors of production sell their factors at market
prices. Labour earns money wages, capital earns interest, land
earns rent and an entrepreneur earns profit. All these factor
incomes constitute the national income. Thus, the distribution of
 national income among the owners is also determined by the
money prices of these factors.
- Basis of Credit System
Credit plays a very important role in the modern economy as
business and commercial activities heavily rely on it. It is money
that provides the basis of the entire credit system. Without money,
the credit instruments like cheques, bills of exchange, etc cannot
be used.
6. What is meant by supply of money?
[2]
Supply of money in any country refers to the amount of money held
by the public at any point of time as a means of payments and store of

value. It is a stock concept .

State the various measures of money supply used in India.
[2]
▪ M1 = Rupee notes and coins with the public (C) + demand deposits
with the commercial banks (DD) + other deposits with the Reserve
Bank (OD)
▪ M2 = M1 + Postal savings bank deposits .
▪ M3 = M1 + (Net) Time deposits with the commercial banks.
▪ M4 = M3 + Total deposits with the postal savings organisation
(excluding National Savings Certificates.
Kindly note:
• M1 and M2 are considered as Narrow money; M3 and M4 are
considered as Broad Money.
• M1 is supposed to be most liquid and M4 is supposed to be least
liquid.
• Net time deposits are Gross time deposits (-) inter-bank time
deposits with commercial banks. Only time deposits of people are
considered.
• NSC is excluded as people cannot withdraw or take loans against
those certificates.
• If M2, M3 or M4 are asked separately, all components must be
individually mentioned.
7. Define High-powered Money.
[2]
High powered money refers to the total liability of the monetary
authority (say, RBI) of the country. It consists of:
• Currency held by the public;
• Cash reserves with the commercial banks;
• Required reserves of the commercial bank to be maintained with the
RBI; and
• Other deposits with RBI
It is called the Reserve Money or Monetary Base, as the overall
money supply ultimately depends on amount of money issued by the
Central bank. It is called high-powered as the monetary base has a
multiplied effect on the money supply.