Money: NBSE Class 12 Economics chapter 7 notes

Introduction

Money, a crucial invention of modern times, has undergone a long process of historical evolution. Initially, human beings engaged in barter exchanges, where goods were directly swapped for one another. However, the inconvenience and drawbacks of this system led to the gradual use of a medium of exchange known as money.

Money serves several primary functions. Firstly, it acts as a medium of exchange, facilitating the trade of goods and services. This function has solved the problem of lack of coincidence in barter, as money separates the act of purchase from sale. Money also provides freedom of choice to buy things one wants most from those who offer the best bargain.

Secondly, money serves as a unit of account or measure of value. This makes it easy to measure the exchange value of each commodity. Different goods produced in a country are measured in different units like cloth in meters, milk in liters, and sugar in kilograms. Without a common unit, exchange of goods becomes very difficult. Thus, money is used as a common measure for quoting prices.

Thirdly, money is used as the standard of deferred payments. Deferred payments are payments which are contracted to be made some time in the future. Debts are usually expressed in terms of money. The use of money as the standard of deferred or delayed payments simplifies borrowing and lending operations because money generally maintains a constant value through time.

Lastly, money serves as a store of value. It can be stored as an asset for use in the future. By spending it, we can get any commodity in the future. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People, therefore, normally wish to keep a part of their wealth in the form of money because savings in terms of goods are very difficult. This desire is known as liquidity preference.

Textual questions and answers

A. Very short-answer questions

1. What is barter system?

Answer: Barter system is the direct exchange of goods against goods without the use of money.

2. What is bank money?

Answer: Bank money refers to credit created by commercial banks by way of cheques, bank drafts, pay orders, etc.

3. What is credit money?

Answer: Credit money refers to the money whose intrinsic value (as a commodity) is much lower than its face value.

4. What is money supply?

Answer: Money supply means the total stock of money (currency and demand deposits of banks) in circulation held by public at any point of time.

5. Define a bank.

Answer: A bank is a financial institution that accepts deposits and channels those deposits into lending activities.

6. What is the main function of money?

Answer: The main function of money is to act as a medium of exchange.

7. What is e-economy?

Answer: E-economy refers to electronic transactions and deals conducted over the internet using electronic money.

8. State any two problems of barter system.

Answer: Two problems of barter system are: (i) lack of double coincidence of wants, and (ii) lack of common measure of value.

9. How does money help store wealth?

Answer: Money helps store wealth by providing a convenient and liquid form to store purchasing power for future use.

10. How does money act as a measure of value?

Answer: Money acts as a measure of value by providing a common unit to express the values of different goods and services as prices.

11. In what way does barter system face the problem of divisibility? Give an example.

Answer: Barter system faces the problem of divisibility as commodities cannot be divided into small units. For example, a farmer cannot exchange half a cow to get equivalent value of cloth.

12. Define money supply.

Answer: Money supply means the total stock of money in circulation held by public at any point of time.

13. What is high-powered money?

Answer: The total liability of the monetary authority (RBI), consisting of currency and deposits of banks with RBI, is called high-powered money.

B. Short-answer questions-I

1. What is barter exchange?

Answer: Barter exchange refers to the direct exchange of goods and services without the use of money. In this system, goods are directly exchanged for other goods.

2. How can money be defined?

Answer: Money can be defined as anything that is generally accepted as a medium of exchange and at the same time acts as a measure and a store of value. Money is the centre around which economic science clusters.

3. What is the main function of money in an economic system?

Answer: The main function of money in an economic system is to facilitate exchange of goods and services and help carry on trade smoothly. Money helps maximize consumers’ satisfaction and producers’ profit.

4. What monetary system does India follow?

Answer: India follows the ‘Paper Currency Standard’ also known as ‘Managed Currency Standard’ because any amount of notes can be issued with minimum back-up of gold.

5. What are primary functions of money?

Answer: The primary functions of money are to act as a medium of exchange and a measure of value. Money as a medium of exchange has solved the problem of lack of coincidence in barter, as money has separated the act of purchase from sale.

6. What is a cheque?

Answer: A cheque is a type of credit instrument. It is used as money but does not have any legal sanction behind it. It is a form of non-legal tender money, meaning its acceptance is optional.

7. What are secondary function of money?

Answer: The secondary functions of money are to act as a standard of deferred payments and a store of value. Money as the standard of deferred payments simplifies borrowing and lending operations because money generally maintains a constant value over time.

8. What is money supply?

Answer: The supply of money refers to the total stock of money (currency and demand deposits of banks) in circulation held by the public at any point in time.

9. What are two components of supply of money?

Answer: There are two components of money supply namely (i) Currency (Paper notes and coins) and (ii) Demand deposits of people with commercial banks. Since demand deposits are chequable deposits, they are treated like notes which can be directly used for making payments.

10. What is credit money?

Answer: Credit money refers to the money whose intrinsic value (as a commodity) is much lower than its face value, i.e. Money Value > Commodity Value. It includes token coins, circulating promissory notes, and demand deposits.

11. Who are the producers of money?

Answer: The producers of money are: (i) government (which issues one-rupee notes and all other coins), (ii) RBI (which issues paper currency), and (iii) commercial banks (which create credit on the basis of demand deposits). Among these, RBI is the principal supplier of money.

12. What are the two main problems of barter system?

Answer: The two main problems of the barter system are

Lack of double coincidence of wants: Barter system requires a double coincidence of wants. What one person wants to sell and buy must coincide with what some other person wants to buy and sell.
Lack of common measure of value: In barter, there is no common measure (unit) of value. Each article must have as many different values as there are other articles for which it is to be exchanged.

13. What are the components of money supply?

Answer: The components of money supply are (i) Currency (Paper notes and coins) and (ii) Demand deposits of people with commercial banks. Demand deposits are chequable deposits, they are treated like notes which can be directly used for making payments

14. State the sources of money supply.

Answer: The sources of money supply are: (i) government (which issues one-rupee notes and all other coins), (ii) RBI (which issues paper currency), and (iii) commercial banks (which create credit on the basis of demand deposits). Among these, RBI is the principal supplier of money

C. Short-answer questions-II

1. How was money invented? How did it solve the problems of barter system?

Answer: Money was invented to overcome the disadvantages of the barter system.

The barter system faced issues such as lack of double coincidence of wants, lack of common measure of value, lack of standard of deferred payment, difficulty in storing wealth, and lack of divisibility. Money, being generally acceptable by the people in exchange of goods and services or in repayment of debts, solved these problems.

2. What is money? Write its primary functions.

Answer: Money is anything that is commonly accepted as a medium of exchange.

The primary functions of money are to act as a medium of exchange and a measure of value. As a medium of exchange, money facilitates the exchange of goods and services, promotes specialisation, and increases productivity and efficiency. As a measure of value, money serves as a common unit for quoting prices and makes it easy to measure the exchange value of each and every commodity.

3. Discuss the secondary functions of money.

Answer: The secondary functions of money are to act as a standard of deferred payments and a store of value. As a standard of deferred payments, money simplifies borrowing and lending operations because it generally maintains a constant value over time. It is the link which connects the values of today with those of the future. As a store of value, money can be stored as an asset for use in future. It serves as a store value of goods in liquid form. By spending it, we can get any commodity in future.

4. “Money is a unit of account”. Explain.

Answer: Money serves as a unit of account or a measure of value. This means that the monetary unit is that unit in terms of which the value of all goods and services is measured and expressed. The value is expressed as price. Money as a unit of value makes keeping business accounts easy because all business transactions are expressed in money. Money serves as a common unit of account or a measure of value, making it easy to measure the exchange value of each and every commodity.

5. “Money is medium of Exchange”. Explain.

Answer: Money as a medium of exchange is the basic or primary function of money. People exchange goods and services through the medium of money. Money acts as an intermediary in the exchange of payments. The use of money facilitates exchange, exchange promotes specialisation, specialisation increases productivity and efficiency. A good monetary system is, therefore, of immense utility to human society. Money is also called a bearer of options or generalised purchasing power because it provides freedom of choice to buy things one wants most from those who offer the best bargain.

6. “Money is the standard of deferred payment”. Explain.

Answer: Deferred payments are payments which are contracted to be made some time in the future. Debts are usually expressed in terms of money. Deferred payments are the postponed payments to be made in the future. Loans are taken and repaid in terms of money. The use of money as the standard of deferred or delayed payments immensely simplifies borrowing and lending operations because money generally maintains a constant value through time. Money is the link which connects the values of today with those of the future.

7. What is the legal and functional definition of money?

Answer: Money may be defined as anything which is generally acceptable by the people in exchange of goods and services or in repayment of debts. Legal tender money is money that has a legal sanction by the government behind it.

8. Do credit cards act as money? Comment.

Answer: Credit cards are not considered money. They are a means of obtaining a short-term loan for a purchase. They do not represent a store of value as money does, but they provide a method of transferring that value.

9. Write a note on money supply.

Answer: The supply of money means the total stock of money (currency and demand deposits of banks) in circulation held by public at any point of time. The Reserve Bank of India uses four alternative measures of money supply called M1, M2, M3 and M4. M1 = Currency (paper notes and coins) + Demand Deposits + Other Deposits. M2 = M1 + Saving deposits with Post Office Saving Banks. M3 = M1 + Net Time-deposits of Banks. M4 = M3 + Total deposits with Post Office Saving Organisation (excluding NSC). The amount of money which keeps aggregate demand (i.e., total purchasing power) in a state of balance with aggregate supply is called an ideal supply of money. It keeps the economy in stable condition and saves it from stepping into inflationary or deflationary situation.

D. Long-answer questions-I

1. Define barter system. What were the problems with barter system?

Answer: The barter system is a direct exchange of goods against goods without the use of money. It is a system of exchange in which transactions are made by exchange of goods. The problems with the barter system include:

Lack of double coincidence of wants: Barter system requires a double coincidence of wants, which means the situation when A has what B wants to buy and B has what A wants to buy.
Lack of common measure of value: In barter, there is no common measure (unit) of value, leading to difficulties in determining the proportion in which goods are to be exchanged.
Lack of standard of deferred payment: There is a problem of borrowing and lending due to lack of any satisfactory unit.
Difficulty in storing wealth (or generalized purchasing power): It is difficult for people to store wealth or generalized purchasing power for future use in the form of goods like cattle, wheat, potatoes, etc.
Lack of divisibility: It’s challenging to exchange goods of unequal value.

2. What is money? Discus in detail its primary functions.

Answer: Money is anything that is generally acceptable by the people in exchange of goods and services or in repayment of debts. The primary functions of money are:

Money as the Medium of Exchange: Money came into use to remove the inconvenience of barter, especially the problem of lack of coincidence.
Money as a Unit of Account or Measure of Value: Money serves as a common unit of account or a measure of value.
Money as the Standard of Deferred Payments: Deferred payments are payments which are contracted to be made some time in the future.
Money as a Store of Value: It means money can be stored as an asset for use in future. It serves as a store value of goods in liquid form.

3. Define money. What are its secondary functions?

Answer: Money is defined as anything which is generally acceptable by the people in exchange of goods and services or in repayment of debts.

The secondary functions of money are to act as a standard of deferred payments and a store of value. The use of money as the standard of deferred or delayed payments simplifies borrowing and lending operations because money generally maintains a constant value through time. Money is the link which connects the values of today with those of the future.

4. Explain how does money act as a store of value and as standard of deferred payment,

Answer: Money acts as a store of value in the sense that it can be stored as an asset for use in future. It serves as a store value of goods in liquid form. By spending it, we can get any commodity in future. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People, therefore, normally wish to keep a part of their wealth in the form of money because savings in terms of goods are very difficult. This desire is known as liquidity preference.

5. Give any four advantages of money.

Answer: The four advantages of money are:

It facilitates the exchange of goods and services and helps carry on trade smoothly. The present highly complicated economic system will not exist without money.
Money helps maximize consumers’ satisfaction and producers’ profit. It helps and promotes saving.
Money promotes specialization which increases productivity and efficiency.
It facilitates planning of both production and consumption.

6. How is limited legal tender money different from unlimited legal tender?

Answer: limited legal tender is the money which can be accepted only up to a certain maximum limit fixed by law. For instance, in India, coins are limited legal tender because coins of 1, 2, 5, 10 are accepted up to a maximum sum of Rs 1,000. Beyond this limit, one can refuse payment in these small coins.

On the other hand, unlimited legal tender is the money for which there is no limit to the quantity of money offered in a payment at a time. For example, in India, paper notes are unlimited legal tender because all currency notes can be used for settling payments of unlimited value.

7. What is liquidity trap? Explain with the help of an example.

Answer: A liquidity trap is a situation of very low rate of interest where people expect the interest rate to rise in the future and consequently bond prices to fall. So, it becomes totally unattractive to invest money in bonds causing capital loss.

People withhold, as an inactive balance, any amount of money they have and nothing is invested. In such a situation, when the rate of interest declines to a minimum, say 3%, speculative demand for money becomes infinite (perfectly elastic) making the demand curve a horizontal straight line curve parallel to the X-axis beyond a point. Economists call it a situation of liquidity trap because expansion in money supply gets trapped in the sphere of liquidity trap and, therefore, cannot affect the rate of interest.

8. Explain the components of money supply.

Answer: The components of money supply are currency (paper notes and coins) and demand deposits of people with commercial banks.

Since demand deposits are chequable deposits, they are treated like notes which can be directly used for making payments. In India, the Reserve Bank of India uses four alternative measures of money supply called M1, M2, M3, and M4. They are arranged in descending order of their liquidity. Among these measures, M1 is the most commonly used measure of money supply because its components are regarded as the most liquid assets.

E. Long-answer questions-II

1. Discuss in detail the problem of barter system.

Answer: The barter system is a direct exchange of goods against goods without the use of money. The following are some of the drawbacks or inconveniences of barter:

Lack of double coincidence of wants: Barter system requires a double coincidence of wants. Double coincidence of wants means the situation when A has what B wants to buy and B has what A wants to buy.
Lack of common measure of value: In barter, there is no common measure (unit) of value. Even if the buyer and the seller of each other’s commodity happen to meet, the problem arises in what proportion the two goods are to be exchanged.
Lack of standard of deferred payment: There is a problem of borrowing and lending. It is difficult to engage in contracts which involve future payments due to lack of any satisfactory unit.
Difficulty in storing wealth (or generalized purchasing power): It is difficult for the people to store wealth or generalized purchasing power for future use in the form of goods like cattle, wheat, potatoes, etc.
Lack of divisibility: Some goods cannot be divided without loss of value. For example, if a household wants to sell his cow and get in exchange cloth equal to the value of half of his cow, he cannot do so without killing his cow.

2. What do you mean by money? Explain the functions of money.

Answer: Money may be defined as anything which is generally acceptable by the people in exchange of goods and services or in repayment of debts.

The primary functions of money are to act as a medium of exchange and a measure of value. The secondary functions of money are to act as a standard of deferred payments and a store of value. Money as a medium of exchange facilitates trade, promotes specialization, and increases productivity and efficiency. As a unit of account, money provides a common measure for quoting prices, making it easy to measure the exchange value of each commodity. Money as the standard of deferred payments simplifies borrowing and lending operations because it generally maintains a constant value over time. Lastly, money as a store of value means it can be stored as an asset for use in the future. It serves as a store value of goods in liquid form. By spending it, we can get any commodity in the future.

3. Explain how money acted as a solution to the problems of barter system.

Answer: Money came into use to remove the inconvenience of barter, especially the problem of lack of coincidence of wants. Money as a medium of exchange has solved this problem as money has separated the act of purchase from sale. Money also solved the barter problem of a common measure of value. Without a common unit, exchange of goods becomes very difficult. Thus, money is used as a common measure for quoting prices. Money as a unit of account has removed the barter problem of a common measure. Money as the standard of deferred payments helps to solve the barter problem of lack of standard of deferred payment. It helps to make contracts which involve future payments. Doubtlessly, money helps remove the difficulties of the barter system.

4. Differentiate between the legal definition and the functional definition of money.

Answer: The legal definition of money refers to money that has a legal sanction by the government behind it, also known as legal tender or legal tender money. Legal tender or legal money means money under the law of the land. It is the money issued by the monetary authority or government which cannot be refused by any person in payment for transactions. The government issues an order stating what is money and that becomes legal tender money. Everybody is bound to accept it in exchange for goods and services and in discharge of debts.

On the other hand, the functional definition of money is defined in terms of its functions. Accordingly, money is that which money does. It is based on the four functions of money — a medium, a measure, a standard, a store—already discussed. Broadly, anything which is generally accepted in payment of debt and as payment of goods and services should be included in money. Alternatively, if a good is generally acceptable in payment and generally used as a medium of payment, it should be treated as money, no matter what its legal status is.

Additional/extra questions and answers

1. What is Barter Exchange?

Answer: Direct exchange of goods against goods without use of money is called barter exchange. It is a system of exchange in which transactions are made by exchange of goods.

2. What is a C.C. Economy?

Answer: An economy based on barter exchange, which is the exchange of goods for goods, is called a C.C. Economy, meaning a commodity for commodity exchange economy.

3. What are the two components of trading costs?

Answer: Trading costs are the costs of engaging in trade. Its two components are search cost and disutility of waiting.

4. Define search cost. What is the disutility of waiting?

Answer: Search cost is the high cost of searching for suitable persons to exchange goods.

The disutility of waiting refers to the time period spent on searching for the required person.

5. What is meant by double coincidence of wants?

Answer: Double coincidence of wants means the situation when person A has what person B wants to buy, and person B has what person A wants to buy. In other words, what one person wants to sell and buy must coincide with what some other person wants to buy and sell. The simultaneous fulfilment of mutual wants by buyers and sellers is known as double coincidence of wants.

6. What is the main drawback of the barter exchange?

Answer: The lack of coincidence of wants is the main drawback of the barter exchange.

7. What problem arises from the lack of a common measure of value?

Answer: In a barter system, there is no common measure of value. This creates a problem in determining the proportion in which two goods are to be exchanged. Each article must have as many different values as there are other articles for which it is to be exchanged, leading to an unlimited number of exchange ratios and creating many difficulties.

8. Why is it difficult to make future payments in a barter system?

Answer: In a barter system, it is difficult to engage in contracts that involve future payments due to the lack of any satisfactory unit. Future payments must be stated in terms of specific goods or services, which can lead to disagreement about the quality of the goods, the specific type of goods, and changes in the value of the goods over time.

9. What is the difficulty in storing wealth in a barter system?

Answer: It is difficult for people to store wealth or generalised purchasing power for future use in the form of goods like cattle, wheat, or potatoes. Holding stocks of such goods involves costly storage and deterioration. Moreover, not all goods may be acceptable as a medium of exchange.

10. How does the lack of divisibility make barter exchange impossible?

Answer: The lack of divisibility of goods makes barter exchange impossible when trying to exchange goods of unequal value. For example, if a household wants to sell its cow and get cloth equal to the value of half of its cow in exchange, it cannot do so without killing the cow.

11. What is the fundamental characteristic of money?

Answer: General acceptability is the fundamental characteristic of money.

12. What are the primary functions of money?

Answer: The primary functions of money are to act as a medium of exchange and a measure of value.

13. What are the secondary functions of money?

Answer: The secondary functions of money are to act as a standard of deferred payment and a store of value.

14. What is meant by the liquidity of money?

Answer: Liquidity means convertibility into cash. The ability to convert an asset into money quickly and without loss of value is called the liquidity of an asset. By definition, money is the most liquid of all resources.

15. How does money promote specialisation and efficiency?

Answer: The use of money facilitates exchange. Exchange promotes specialisation, and specialisation increases productivity and efficiency.

16. What is legal tender money?

Answer: Money that has a legal sanction by the government behind it is called legal tender money. It is money under the law of the land, issued by a monetary authority or government, which cannot be refused by any person in payment for transactions.

17. What is limited legal tender? Give an example from India.

Answer: Limited legal tender is money that can be accepted only up to a certain maximum limit fixed by law. For instance, in India, coins are limited legal tender because coins of 1, 2, 5, and 10 are accepted up to a maximum sum of ₹ 1000 as per the Coinage Bill passed on 11th August, 2011.

18. What is unlimited legal tender?

Answer: It is the money for which there is no limit to the quantity of money offered in a payment at a time. For example, in India, paper notes are unlimited legal tender.

19. What is non-legal tender money? Give an example.

Answer: Non-legal tender money refers to a form of money whose acceptance is optional. For example, credit instruments like cheques, drafts, and bills of exchange are in use as money but have no legal sanction behind them, and people can legally refuse to accept them.

20. What is the functional definition of money?

Answer: The functional definition of money defines it in terms of its functions. Accordingly, money is that which money does. It is based on the four functions of money: a medium, a measure, a standard, and a store. Broadly, anything which is generally accepted in payment of debt and as payment of goods and services should be included in money.

21. Differentiate between the face value and intrinsic value of money?

Answer: Every unit of money has two values:

Face Value: refers to the value which is written on the unit of money. For example, the face value of a ten-rupee note is equal to ten rupees.
Intrinsic Value: refers to the value of the metal contained in the unit of money. For example, the value of silver contained in a silver coin is known as its intrinsic value.

22. What is full-bodied money?

Answer: Any unit of money whose face value and intrinsic value are equal is known as full-bodied money, where Money Value equals Commodity Value.

23. What is credit money?

Answer: Credit money refers to money whose intrinsic value as a commodity is much lower than its face value, where Money Value is greater than Commodity Value.

24. What are token coins?

Answer: Token coins refer to small coins of various denominations which are issued to facilitate the day-to-day requirements of the people. All Indian coins, like those of ₹10, 5, 2, or 1, are token coins since their value as money is more than the value of the metal contained in them.

25. What are circulating promissory notes issued by a central bank?

Answer: These are currency notes issued by the Reserve Bank in India, including all denominations like ₹500, ₹100, etc. Each promissory note contains the words, “I promise to pay the bearer the sum of ₹…….”, and is signed by the Governor of India. The commodity value of a promissory note is much less than its money value.

26. What are demand deposits in a bank?

Answer: Demand deposits are claims of creditors (depositors) against a bank. These deposits can be withdrawn from the bank or transferred from one person to another by issuing a cheque.

27. What is fiat money? Why is it also called legal tender?

Answer: Fiat money is money that is issued by the order (fiat) of the government to act as money. People have to accept it in exchange for goods and services and in discharge of debt as the government has ordered it to be money. It is also called legal tender as it circulates in the country on the fiat (command) of the government.

28. What is fiduciary money? Why is it called non-legal tender?

Answer: Fiduciary money is money that is accepted as money on the basis of the trust that the issuer commands, not on the basis of any order of the government. For example, cheques and drafts are fiduciary money. It is also called non-legal tender because its acceptance is optional and voluntary.

29. What is a liquidity trap?

Answer: A liquidity trap is a situation with a very low rate of interest where people expect the interest rate to rise in the future and consequently bond prices to fall, making it unattractive to invest in bonds. In such a situation, an expansion in the money supply gets trapped in the sphere of liquidity and cannot affect the rate of interest.

30. What is the monetary system in India called?

Answer: The Indian monetary system is called ‘Paper Currency Standard’ or ‘Managed Currency Standard’.

31. What is the Minimum Reserve System?

Answer: For note issue, the RBI uses the Minimum Reserve System, according to which the RBI maintains a minimum reserve of ₹ 200 crore, of which ₹115 crore is in gold and the remaining ₹ 85 crore is in the form of foreign securities.

32. Who issues currency notes and coins in India?

Answer: In India, the RBI issues all paper notes except one-rupee notes and coins. The RBI has the sole monopoly to issue currency notes in India from ₹ 2 and above. The Central Government (Ministry of Finance) issues one-rupee notes and all coins.

33. Who are the suppliers of money in an economy?

Answer: The sources or suppliers of money are:

(i) the government, which issues one-rupee notes and all other coins,
(ii) the RBI, which issues paper currency, and
(iii) commercial banks, which create credit on the basis of demand deposits.

34. What is an ideal supply of money?

Answer: The amount of money which keeps aggregate demand (total purchasing power) in a state of balance with aggregate supply is called an ideal supply of money. It keeps the economy in a stable condition.

35. What is the impact of too much supply of money on an economy?

Answer: If there is too much supply of money, people will have too much purchasing power and demand more goods and services. If goods and services are not available in sufficient quantity, prices will shoot up, and the economy will fall into a vicious circle of inflation.

36. What is the impact of too little supply of money on an economy?

Answer: If there is too little supply of money, people will have too little purchasing power and will demand fewer goods and services. A persistent fall in demand will cause depression, leading to a vicious circle of deflation.

37. What are the four alternative measures of money supply in India?

Answer: In India, the Reserve Bank of India uses four alternative measures of money supply called M₁, M₂, M₃, and M₄.

38. What does the M1 measure of money supply include?

Answer: The M1 measure of money supply is calculated as M₁ = C + DD + OD. Here, C denotes currency (paper notes and coins) held by the public, DD stands for demand deposits of people in banks, and OD stands for other deposits in the RBI, which includes demand deposits of public financial institutions and foreign central banks.

39. Define high-powered money. What does it consist of?

Answer: The total liability of the monetary authority of the country, the RBI, is called the monetary base or high-powered money. It is the money created or produced by the RBI/Government of India. It consists of (i) currency (notes and coins) in circulation with the public, (ii) vault cash of commercial banks, and (iii) deposits held by the government and commercial banks with the RBI.

40. What is bank money? How is it different from high-powered money?

Answer: Bank money is different from high-powered money because bank money refers to credit created by commercial banks by way of cheques, bank drafts, pay orders, etc.

41. Explain the evolution of money from commodity money to e-money.

Answer: The need to facilitate the exchange of goods led to the evolution of money. The evolution of money was mainly through commodity money, metallic money, paper money and bank money. Human beings passed through a stage when money was not in use and goods were exchanged directly for one another. This was called Barter Exchange. The inconvenience and drawbacks of barter led to the gradual use of a medium of exchange called Money.

As the volume of transactions increased, even paper money started becoming inconvenient because of the time involved in its counting and the space required for its safe keeping. This led to the introduction of Bank Money (or credit money) in the form of cheques, drafts, bills of exchange, credit cards, etc. These days, plastic money in the form of debit cards is becoming popular. The latest edition is e-money, which is the electronic transfer of money in terms of credit/debit entries.

42. What is barter exchange? Explain with an example.

Answer: The direct exchange of goods against goods without the use of money is called barter exchange. It is a system of exchange in which transactions are made by the exchange of goods. An economy based on barter exchange is called a C.C. Economy, which means a commodity for commodity exchange economy. In such an economy, a person gives his surplus good and gets in return the good he needs.

For example, when a weaver gives cloth to the farmer in return for getting wheat from the farmer, this is called barter exchange. Similarly, the farmer can get other goods of his requirements like shoes, cow, plough, or spade by giving his surplus wheat, rice, or maize.

43. Explain the inconvenience of ‘lack of double coincidence of wants’.

Answer: The barter system requires a double coincidence of wants. Double coincidence of wants means the situation when person A has what person B wants to buy, and person B has what person A wants to buy. In other words, what one person wants to sell and buy must coincide with what some other person wants to buy and sell. The simultaneous fulfilment of mutual wants by buyers and sellers is known as double coincidence of wants.

There is a lack of double coincidence in the wants of buyers and sellers. The buyer has to search for a seller who also wants to buy the same goods which the buyer offers for exchange. For instance, a producer of jute may want shoes in exchange for his jute. But he may find it difficult to get a shoe-maker who is also willing to exchange his shoes for jute. Thus, a seller has to find a person who wants to buy the seller’s good and at the same time who must have what the seller wants. This lack of coincidence of wants is the main drawback of the barter exchange and involves two trading costs: search cost and disutility of waiting.

44. How did the ‘lack of a common measure of value’ create difficulties in barter?

Answer: In barter, there is no common measure or unit of value. Even if the buyer and the seller of each other’s commodity happen to meet, the problem arises in what proportion the two goods are to be exchanged. Each article must have as many different values as there are other articles for which it is to be exchanged. When thousands of articles are produced and exchanged, there will be an unlimited number of exchange ratios. The absence of a common denominator to express exchange ratios creates many difficulties.

45. Explain the problem of ‘lack of standard of deferred payment’ in a barter system.

Answer: In a barter system, there is a problem of borrowing and lending. It is difficult to engage in contracts which involve future payments due to the lack of any satisfactory unit. As a result, future payments have to be stated in terms of specific goods or services. However, there could be disagreement about the quality of the goods, the specific type of the goods, and changes in the value of the goods.

46. Why was it difficult for people to store wealth under the barter system?

Answer: It is difficult for people to store wealth or generalised purchasing power for future use in the form of goods like cattle, wheat, potatoes, etc. Holding stocks of such goods involves costly storage and deterioration. Moreover, all goods may not be acceptable as a medium of exchange.

47. Explain how money functions as a ‘medium of exchange’.

Answer: Money came into use to remove the inconvenience of barter, especially the problem of lack of coincidence. Money as a medium of exchange has solved this problem as money has separated the act of purchase from sale.

Medium of exchange is the basic or primary function of money. People exchange goods and services through the medium of money. Money acts as a medium of exchange or as a medium of payments. Money by itself has no utility, except perhaps to a miser; it is only an intermediary. The use of money facilitates exchange, which in turn promotes specialisation, and specialisation increases productivity and efficiency.

48. How does money serve as a ‘unit of account’ or ‘measure of value’?

Answer: The unit of account function means that the money unit is treated as the standard unit for quoting prices and for borrowing and lending activities. The monetary unit is that unit in terms of which the value of all goods and services is measured and expressed. The value is expressed as price. Money as a unit of value makes keeping business accounts easy because all business transactions are expressed in money.

Money serves as a common unit of account or a measure of value. This makes it easy to measure the exchange value of each and every commodity. Different goods produced in the country are measured in different units, like cloth in metres, milk in litres, and sugar in kilograms. Without a common unit, the exchange of goods becomes very difficult. Thus, money is used as a common measure for quoting prices and has removed the barter problem of a common measure.

49. Explain money’s role as a ‘standard of deferred payments’.

Answer: Deferred payments are payments which are contracted to be made some time in the future. Debts are usually expressed in terms of money. Deferred payments are postponed payments to be made in the future. Loans are taken and repaid in terms of money. The use of money as the standard of deferred or delayed payments immensely simplifies borrowing and lending operations because money generally maintains a constant value through time. Money is the link which connects the values of today with those of the future.

50. Explain how money serves as a ‘store of value’.

Answer: Money can be stored as an asset for use in the future. It serves as a store of value of goods in liquid form. By spending it, one can get any commodity in the future.

Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People normally wish to keep a part of their wealth in the form of money because savings in terms of goods are very difficult. This desire is known as liquidity preference. Money is the best form of store of value. Wheat or any other product which will command a value cannot be stored for a long period. The desire for money (cash) is known as liquidity preference.

51. How has money overcome the main drawbacks of the barter system?

Answer: Money has overcome the drawbacks of the barter system, which make the exchange process burdensome and highly inefficient. The barter system suffers from four main drawbacks, each of which is overcome by a specific function of money as explained below:

(i) Money as a medium of exchange solves the barter problem of lack of double coincidence of wants as money has separated the acts of sale and purchase. You can sell goods for money to whosoever wants it and with this money you can buy goods from whosoever wants to sell them.
(ii) Money as a measure (unit) of value or a unit of account solves the barter’s problem of the absence of a common measure (unit) of value. Money serves as a unit of value and acts as a yardstick to measure the exchange value of all commodities. The value of each good or service is expressed as price.
(iii) Money as a store of value solves the barter problem of difficulty in storing wealth. Moreover, money in convenient denominations solves the barter problem of absence or lack of divisibility.
(iv) Money as a standard of deferred payments helps to solve the barter problem of lack of a standard of deferred payment. It helps to make contracts which involve future payments.

52. What is legal tender money? Explain its two types with examples.

Answer: Legal Tender Money is money that has a legal sanction by the government behind it. It is money under the law of the land, issued by a monetary authority or government, which cannot be refused by any person in payment for transactions. The government issues an order stating what is money, and that becomes legal tender money.

Legal tender status given by the government to money is of two types: limited legal tender and unlimited legal tender.

(i) Limited legal tender is the money which can be accepted only up to a certain maximum limit fixed by law. For instance, in India, coins are limited legal tender because coins of 1, 2, 5, and 10 are accepted up to a maximum sum of ₹ 1000 as per the Coinage Bill passed on 11th August, 2011.
(ii) Unlimited legal tender is the money for which there is no limit to the quantity of money offered in a payment at a time. For example, in India, paper notes are unlimited legal tender because all currency notes can be used for settling payments of unlimited value.

53. What is full-bodied money? How is it different from credit money?

Answer: Any unit of money whose face value and intrinsic value are equal is known as full-bodied money, where Money Value = Commodity Value. For example, during the British period, one rupee coin was made of silver and its value as money was the same as its value as a commodity.

Credit money is different as it refers to money whose intrinsic value (as a commodity) is much lower than its face value, where Money Value > Commodity Value. For example, the face value of a ₹100 note is ₹100, but we would get a much lower value if we sell the note as a piece of paper.

54. Explain the various forms of credit money.

Answer: The various forms of credit money are:

(a) Token coins—These refer to small coins of various denominations, which are issued to facilitate the day-to-day requirements of the people. All Indian coins, like those of ₹10, 5, 2 or 1, are token coins since their value as money is more than the value of the metal contained in them.
(b) Circulating promissory notes issued by the central bank—These are currency notes issued by the Reserve Bank in India. These include all currency notes of denominations like ₹500, ₹100, etc. Each promissory note contains the words, “I promise to pay the bearer the sum of…”, and is signed by the Governor of India. The commodity value of a promissory note is much less than its money value.
(c) Demand Deposits in bank—Deposits are claims of creditors (depositors) against the bank. These deposits can be withdrawn from the bank or transferred from one person to another by issuing a cheque. Such deposits do not have backing in terms of any bullion (gold or silver). The commodity value of a cheque is much lower than its money value.

55. What is the ‘Paper Currency Standard’ in India? Why is it also known as ‘Managed Currency Standard’?

Answer: The Indian monetary system is the ‘Paper Currency Standard’ because here standard money is made of paper currency. All currency circulating in the economy is paper currency which is unlimited legal tender money.

The ‘Paper Currency Standard’ is also known as the ‘Managed Currency Standard’ because any amount of notes can be issued with a minimum back-up of gold. In India, for note issue, the RBI uses the Minimum Reserve System, according to which the RBI maintains a minimum reserve of ₹ 200 crore, of which ₹115 crore is in gold and the remaining ₹ 85 crore is in the form of foreign securities.

56. What is money supply? What are its main components?

Answer: The supply of money means the total stock of money (currency and demand deposits of banks) in circulation held by the public at any point of time. The public here excludes suppliers of money like the Central Government, RBI, and Commercial Banks. Only that part of the total stock of money which is held by users/holders is included.

There are two components of money supply:

(i) Currency (Paper notes and coins)
(ii) Demand deposits of people with commercial banks. Since demand deposits are chequable deposits, they are treated like notes which can be directly used for making payments.

57. Explain the concept of a liquidity trap with the help of a diagram.

Answer: A liquidity trap is a situation of a very low rate of interest where people expect the interest rate to rise in the future and consequently bond prices to fall. So, it becomes totally unattractive to invest money in bonds, which would cause a capital loss. People withhold any amount of money they have as an inactive balance, and nothing is invested. In such a situation, when the rate of interest declines to a minimum, say 3%, the speculative demand for money becomes infinite (perfectly elastic), making the demand curve a horizontal straight line parallel to the X-axis beyond a certain point. Economists call this a situation of liquidity trap because expansion in the money supply gets trapped in the sphere of the liquidity trap and, therefore, cannot affect the rate of interest.

[This answer needs the diagram present on Page number 146, Fig. 7.1: Liquidity Trap]

58. Briefly explain the components of M1, M2, M3, and M4 measures of money supply.

Answer: The Reserve Bank of India uses four alternative measures of money supply, arranged in descending order of their liquidity.

(i) M₁ = C + DD + OD. Here, C denotes currency (paper notes and coins) held by the public, DD stands for demand deposits of people in banks, and OD stands for other deposits in RBI. OD includes demand deposits of public financial institutions, and demand deposits of foreign central banks and international financial institutions like the IMF and World Bank. OD does not include cash held by the government, Central Bank, and Commercial Banks in the money supply as they are suppliers of money.
(ii) M₂ = M₁ + Saving deposits with Post Office Saving Banks
(iii) M₃ = M₁ + Net Time-deposits of Banks
(iv) M₄ = M₃ + Total deposits with Post Office Saving Organisation (excluding NSC)

59. What is the barter system? Explain the major inconveniences of barter exchange in detail.

Answer: Direct exchange of goods against goods without use of money is called barter exchange. Alternatively, it is a system of exchange in which transactions are made by exchange of goods. An economy based on barter exchange is called C.C. Economy, i.e. commodity for commodity exchange economy. In such an economy, a person gives his surplus good and gets in return the good he needs.

The major inconveniences or problems of barter exchange are as follows:

Lack of double coincidence of wants: Barter system requires a double coincidence of wants, which means the situation when A has what B wants to buy and B has what A wants to buy. ‘Simultaneous fulfilment of mutual wants by buyers and sellers’ is known as double coincidence of wants. There is lack of double coincidence in the wants of buyers and sellers. The buyer has to make a search for the seller who also wants to buy the same goods which the buyer offers for exchange. Thus, a seller has to find out a person who wants to buy the seller’s good and at the same time who must have what the seller wants. This is the main drawback of the barter exchange, involving two trading costs: (i) Search cost and (ii) Disutility of waiting.
Lack of common measure of value: In barter, there is no common measure (unit) of value. Even if the buyer and the seller of each other’s commodity happen to meet, the problem arises in what proportion the two goods are to be exchanged. Each article must have as many different values as there are other articles for which it is to be exchanged. When thousands of articles are produced and exchanged, there will be an unlimited number of exchange ratios. Absence of a common denominator in order to express exchange ratios creates many difficulties.
Lack of standard of deferred payment: There is a problem of borrowing and lending. It is difficult to engage in contracts which involve future payments due to lack of any satisfactory unit. As a result, future payments are to be stated in terms of specific goods or services. But there could be disagreement about the quality of the goods, specific type of the goods and change in the value of the goods.
Difficulty in storing wealth (or generalised purchasing power): It is difficult for people to store wealth or generalised purchasing power for future use in the form of goods like cattle, wheat, potatoes, etc. Holding of stocks of such goods involves costly storage and deterioration. Moreover, all goods may not be acceptable as a medium of exchange.
Lack of divisibility: To exchange goods of unequal value is a problem. If a household wants to sell his cow and get in exchange cloth equal to the value of half of his cow, he cannot do so without killing his cow. Thus, lack of divisibility of goods makes barter exchange impossible.

60. “Money is a matter of functions four: A medium, a measure, a standard, a store.” Explain this statement.

Answer: This statement, a well-known couplet, reflects the four main functions that money conventionally performs in an economic system. Each of these functions overcomes one or the other difficulty of the barter system. The four functions are:

A medium (of Exchange): This is the basic or primary function of money. People exchange goods and services through the medium of money. Money acts as an intermediary, and its use facilitates exchange, which in turn promotes specialisation, productivity, and efficiency. Money has separated the act of purchase from sale, removing the inconvenience of barter.
A measure (of Value or Unit of Account): The money serves as a common unit of account or a measure of value. This makes it easy to measure the exchange value of each and every commodity. The value of all goods and services is measured and expressed in terms of money, and this value is expressed as price. This makes keeping business accounts easy because all business transactions are expressed in money, removing the barter problem of a common measure.
A standard (of Deferred Payments): Deferred payments are payments which are contracted to be made some time in the future. Debts are usually expressed in terms of money, and loans are taken and repaid in terms of money. The use of money as the standard of deferred payments simplifies borrowing and lending operations because money generally maintains a constant value through time. Money is the link which connects the values of today with those of the future.
A store (of Value): This means money can be stored as an asset for use in future. It serves as a store of value of goods in liquid form. By spending it, we can get any commodity in the future. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People normally wish to keep a part of their wealth in the form of money because savings in terms of goods are very difficult.

61. Discuss the primary functions of money. How do they solve the problems of a barter economy?

Answer: Medium of exchange and measure of value are the primary functions of money because they are of prime importance.

The primary functions of money are:

Money as the Medium of Exchange: Money came into use to remove the inconvenience of barter, especially the problem of lack of coincidence. Money as a medium of exchange has solved this problem as money has separated the act of purchase from sale. People exchange goods and services through the medium of money. Money acts as a medium of exchange or as a medium of payments. It is only an intermediary. The use of money facilitates exchange, which promotes specialisation, and specialisation increases productivity and efficiency.
Money as a Unit of Account or Measure of Value: The unit of account function means that the money unit is treated as the standard unit for quoting prices and for borrowing and lending activities. The monetary unit is that unit in terms of which the value of all goods and services is measured and expressed. The value is expressed as price. Money as a unit of value makes keeping of business accounts easy because all business transactions are expressed in money. It serves as a common unit of account, making it easy to measure the exchange value of each and every commodity.

These primary functions solve the major problems of a barter economy in the following ways:

Money as a medium of exchange solves the barter problem of lack of double coincidence of wants. As money has separated the acts of sale and purchase, you can sell goods for money to whosoever wants it and with this money you can buy goods from whosoever wants to sell them. Thus, money becoming an intermediary solves barter’s problem of double coincidence of wants.

Money as a measure (unit) of value or a unit of account solves the barter’s problem of absence of a common measure (unit) of value. Money serves as a unit of value and acts as a yardstick to measure the exchange value of all commodities. The value of each good or service is expressed as price (i.e., money units) which guides both the consumer and the producer to make a transaction.

62. Discuss the secondary functions of money. How are they derived from the primary functions?

Answer: Standard of deferred payment and store of value are called secondary functions.

The secondary functions of money are:

Money as the Standard of Deferred Payments: Deferred payments are payments which are contracted to be made some time in the future. Debts are usually expressed in terms of money. Loans are taken and repaid in terms of money. The use of money as the standard of deferred or delayed payments immensely simplifies borrowing and lending operations because money generally maintains a constant value through time. Money is the link which connects the values of today with those of the future.
Money as a Store of Value: This means money can be stored as an asset for use in future. It serves as a store of value of goods in liquid form. By spending it, we can get any commodity in the future. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things. People, therefore, normally wish to keep a part of their wealth in the form of money because savings in terms of goods are very difficult. Wheat or any other product which will command a value cannot be stored for a long period.

Standard of deferred payment and store of value are called secondary functions because they are derived from primary functions.

63. Explain the legal definition of money. Differentiate between limited and unlimited legal tender with examples.

Answer: The legal definition of money defines money that has a legal sanction by the government behind it, which is called legal tender or legal tender money. Legal tender money means money under the law of land. It is the money issued by a monetary authority or government which cannot be refused by any person in payment for transactions. The government issues an order stating what is money, and that becomes legal tender money. Everybody is bound to accept it in exchange for goods and services and in discharge of debts. For example, in India currency (notes) and coins are legal tender money which cannot be refused in payment of transactions.

Legal tender status given by the government to money is of two types: limited legal tender and unlimited legal tender.

Limited legal tender: It is the money which can be accepted only up to a certain maximum limit fixed by law. For instance, in India, coins are limited legal tender because coins of 1, 2, 5, 10 are accepted up to a maximum sum of ₹1000 as per the Coinage Bill passed on 11th August, 2011. Beyond this limit, one could refuse payments in these small coins.
Unlimited legal tender: It is the money for which there is no limit to the quantity of money offered in a payment at a time. For example, in India, paper notes are unlimited legal tender because all currency notes can be used for settling payments of unlimited value.

64. Classify money on the basis of the relationship between its value as money and its value as a commodity.

Answer: Money can be classified on the basis of the relationship between the value of money as money and the value of money as a commodity. Broadly, money can be classified as Full Bodied money and Credit money.

Full bodied Money: Any unit of money, whose face value and intrinsic value are equal, is known as full bodied money, i.e., Money Value = Commodity Value. The intrinsic value refers to the value of the metal the coin is made of, whereas face value refers to the value marked on the face of the coin. For example, during the British period, one rupee coin was made of silver and its value as money was the same as its value as a commodity.
Credit Money: Credit money refers to the money whose intrinsic value (as a commodity) is much lower than its face value, i.e., Money Value > Commodity Value. For example, the face value of a ₹100 note is ₹100, but we would get a much lower value if we sell the note as a piece of paper. Credit cards and bank deposits are other examples of credit money.

65. What is credit money? Explain its different forms, including token coins, promissory notes, and demand deposits.

Answer: Credit money refers to the money whose intrinsic value (as a commodity) is much lower than its face value, i.e., Money Value > Commodity Value. For example, the face value of a ₹100 note is ₹100, but we would get a much lower value if we sell the note as a piece of paper.

The various forms of credit money are:

(a) Token coins: These refer to small coins of various denominations, which are issued to facilitate day-to-day requirements of the people. All Indian coins, like those of ₹10, 5, 2 or 1, are token coins since their value as money is more than the value of the metal contained in them.
(b) Circulating promissory notes issued by central bank: These are currency notes issued by the Reserve Bank in India. These include all currency notes of denominations like ₹500, ₹100, etc. Each promissory note contains the words, “I promise to pay the bearer the sum of…”, and is signed by the Governor of India. The commodity value of a promissory note is much less than its money value.
(c) Demand Deposits in bank: Deposits are claims of creditors (depositors) against the bank. These deposits can be withdrawn from the bank or transferred from one person to another by issuing a cheque. Such deposits do not have backing in terms of any bullion (gold or silver). The commodity value of a cheque is much lower than its money value. Demand deposits are very convenient for making transactions of huge amounts as they remove the risk of carrying large amounts of cash.

66. Differentiate between fiat money and fiduciary money. Provide examples for each.

Answer: Fiat money and fiduciary money are classifications of credit money.

Fiat Money: Fiat money is that money which is issued by the order (fiat) of the government to act as money. People have to accept it in exchange for goods and services and in discharge of debt as the government has ordered it to be money. It is also called legal tender as it circulates in the country on the fiat (i.e. command) of the government. For example, coins and currency notes in India are fiat money.
Fiduciary Money: Fiduciary money is the money which is accepted as money on the basis of trust that the issuer commands, not on the basis of any order of the government. It is accepted on the basis of trust. It is also called non-legal tender (or money) because its acceptance is optional and voluntary. For example, cheques, drafts, and bills of exchange are fiduciary money because they are accepted on the basis of trust.

67. What do you understand by the supply of money? Who are the sources of money supply in an economy?

Answer: The supply of money means the total stock of money (currency and demand deposits of banks) in circulation held by the public at any point of time. Public here excludes suppliers of money like the Central Government, RBI and Commercial Banks. Only that part of the total stock of money which is held by users/holders is included, and the remaining part lying with producers/suppliers is not included. Simply put, the total stock of money in circulation on a specific day is the money supply of a country.

The sources of money supply, or the suppliers of money, are:

(i) government (which issues one-rupee notes and all other coins),
(ii) RBI (which issues paper currency), and
(iii) commercial banks (which create credit on the basis of demand deposits).

Among these, RBI is the principal supplier of money.

68. Explain the different measures of money supply used by the Reserve Bank of India.

Answer: In India, the Reserve Bank of India uses four alternative measures of money supply called M₁, M₂, M₃ and M₄. They are arranged in descending order of their liquidity. Among these measures, M₁ is the most commonly used measure of money supply because its components are regarded as the most liquid assets. Each measure is explained below.

(i) M₁ = C + DD + OD. Here, C denotes currency (paper notes and coins) held by the public, DD stands for demand deposits of people in banks and OD stands for other deposits in RBI which includes (a) demand deposits of public financial institutions, (b) demand deposits of foreign central banks and international financial institutions like IMF, World Bank, etc. OD does not include cash held by the government, Central Bank and Commercial Banks in the money supply as they are suppliers of money.
(ii) M₂ = M₁ (detailed above) + Saving deposits with Post Office Saving Banks
(iii) M₃ = M₁ + Net Time-deposits of Banks
(iv) M₄ = M₃ + Total deposits with Post Office Saving Organisation (excluding NSC)

69. What is high-powered money? How is it different from bank money created by commercial banks?

Answer: The total liability of the monetary authority of the country, RBI, is called the monetary base or high-powered money. It is the money created/produced by the RBI/Government of India. It consists of (i) currency (notes and coins in circulation with the public), (ii) vault cash of commercial banks, and (iii) deposits held by the government and commercial banks with the RBI. It is high-powered money because it is a liability to refund deposits on demand from the deposit holders. Again, if a person presents a currency note to the RBI, the latter has to pay him a value equal to the amount printed on the note.

Bank money is different from high-powered money. Bank money refers to credit created by commercial banks by way of cheques, bank drafts, pay orders, etc.

70. “Necessity is the mother of invention.” Justify this statement in the context of the evolution of money from the barter system to modern forms.

Answer: The statement “Necessity is the mother of invention” is justified by the evolution of money. The need to facilitate the exchange of goods led to the evolution of money.

Initially, human beings passed through a stage when money was not in use, and goods were exchanged directly for one another. This system was called Barter Exchange. However, the inconvenience and drawbacks of barter created a necessity for a better system, which led to the gradual use of a medium of exchange called Money.

As the volume of transactions increased, even paper money became inconvenient because of the time involved in its counting and the space required for its safe keeping. This necessity led to the introduction of Bank Money, or credit money, in the form of cheques, drafts, bills of exchange, and credit cards. More recently, the need for even more convenient transactions has made plastic money in the form of debit cards popular. The latest evolution driven by necessity is e-money, which involves the electronic transfer of money in terms of credit and debit entries.

71. Explain the meaning and functions of money. Why is money considered one of the most important inventions of modern times?

Answer: Money is anything that is commonly accepted as a medium of exchange. Since general acceptability is the fundamental characteristic of money, it may be defined as ‘anything which is generally acceptable by the people in exchange of goods and services or in repayment of debts.’

In general terms, the main function of money in an economic system is “to facilitate the exchange of goods and services and help carry out trade smoothly.” Conventionally, money performs four main functions, which are reflected in the well-known couplet: “Money is a matter of functions four; A medium, a measure, a standard, a store.” These are:

Medium of Exchange: This is the basic or primary function of money. People exchange goods and services through the medium of money. It acts as an intermediary and separates the act of purchase from sale, solving the problem of lack of double coincidence of wants.
Measure of Value (or Unit of Account): Money serves as a common unit of account or a measure of value. The value of all goods and services is measured and expressed in terms of money as price. This makes it easy to measure the exchange value of each commodity and has removed the barter problem of a common measure.
Standard of Deferred Payments: This is a secondary function. Deferred payments are payments contracted to be made in the future. Debts are usually expressed in terms of money, and loans are taken and repaid in terms of money. This function simplifies borrowing and lending operations.
Store of Value: This is a secondary function. Money can be stored as an asset for use in the future. It serves as a store of value of goods in liquid form. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things.

Money is considered one of the most important inventions of modern times because it occupies a unique position in a modern capitalist economy. In its absence, the whole prosperous economic life would collapse like a pack of cards. Money has overcome the drawbacks of the barter system, which made the exchange process burdensome and highly inefficient. It facilitates the exchange of goods and services, helps maximise consumers’ satisfaction and producers’ profit, promotes specialisation which increases productivity, and enables production to take place ahead of consumption. The whole economic science is based on money; economic motives and activities are measured by money. In the words of Alfred Marshall, “Money is the centre around which economic science clusters.”

72. Provide a detailed classification of money. Explain each type with suitable examples.

Answer: Money can be classified on the basis of the relationship between the value of money as money and the value of money as a commodity. Every unit of money has two values: Face Value, which is the value written on the unit of money, and Intrinsic Value, which is the value of the metal contained in the unit of money. Broadly, money can be classified as Full Bodied money and Credit money.

Full Bodied Money: Any unit of money whose face value and intrinsic value are equal is known as full bodied money, i.e., Money Value = Commodity Value. For example, during the British period, one rupee coin was made of silver and its value as money was the same as its value as a commodity.
Credit Money: Credit money refers to the money whose intrinsic value (as a commodity) is much lower than its face value, i.e., Money Value > Commodity Value. For example, the face value of a ₹100 note is ₹100, but we would get a much lower value if we sell the note as a piece of paper. Credit cards and bank deposits are other examples of credit money. Credit money is further classified as fiat money and fiduciary money.
Fiat Money: Fiat money is that money which is issued by the order (fiat) of the government to act as money. People have to accept it in exchange for goods and services and in discharge of debt as the government has ordered it to be money. It is also called legal tender as it circulates in the country on the fiat (i.e. command) of the government. For example, coins and currency notes in India are fiat money.
Fiduciary Money: Fiduciary money is the money which is accepted as money on the basis of trust that the issuer commands, not on the basis of any order of the government. For example, cheques, drafts, and bills of exchange are fiduciary money because they are accepted on the basis of trust. It is also called non-legal tender because its acceptance is optional and voluntary.

Additional/extra MCQs

1: An economy based on the direct exchange of goods for goods is known as a:

A. Monetary Economy
B. Credit Economy
C. C.C. Economy
D. Digital Economy

Answer: C. C.C. Economy

2: What is the term for the situation where the mutual wants of a buyer and a seller are simultaneously fulfilled in a barter system?

A. Single coincidence of wants
B. Mutual satisfaction
C. Double coincidence of wants
D. Economic equilibrium

Answer: C. Double coincidence of wants

3: Which function of money has solved the problem of a lack of a common measure of value inherent in the barter system?

A. Medium of Exchange
B. Unit of Account
C. Store of Value
D. Standard of Deferred Payment

Answer: B. Unit of Account

4: Money whose face value is equal to its intrinsic value is called:

A. Credit Money
B. Fiat Money
C. Fiduciary Money
D. Full-bodied Money

Answer: D. Full-bodied Money

5: In India, which authority has the sole monopoly to issue currency notes of ₹2 and above?

A. Ministry of Finance
B. Commercial Banks
C. Reserve Bank of India (RBI)
D. The Central Government

Answer: C. Reserve Bank of India (RBI)

6: The total stock of money in circulation held by the public at a specific point in time is referred to as:

A. Money Flow
B. National Income
C. Money Supply
D. High-Powered Money

Answer: C. Money Supply

7: According to the Coinage Bill of 2011, what is the maximum sum up to which coins are accepted as limited legal tender in India?

A. ₹100
B. ₹500
C. ₹1,000
D. ₹2,000

Answer: C. ₹1,000

8: Which measure of money supply includes currency held by the public, demand deposits, and other deposits with the RBI?

A. M4
B. M3
C. M2
D. M1

Answer: D. M1

9: The value of the metal contained in a unit of money is known as its:

A. Face Value
B. Intrinsic Value
C. Commodity Value
D. Both B and C

Answer: D. Both B and C

10: What is the term for money that is accepted based on the trust the issuer commands, rather than a government order?

A. Fiat Money
B. Legal Tender Money
C. Fiduciary Money
D. Full-bodied Money

Answer: C. Fiduciary Money

11: The two components of trading costs in a barter system are search cost and:

A. Production cost
B. Disutility of waiting
C. Transportation cost
D. Storage cost

Answer: B. Disutility of waiting

12: The total liability of the monetary authority of a country, the RBI, is also known as:

A. Bank Money
B. Credit Money
C. Fiat Money
D. High-Powered Money

Answer: D. High-Powered Money

13: In the context of money supply, what does ‘DD’ in the formula M₁ = C + DD + OD stand for?

A. Deferred Deposits
B. Demand Deposits
C. Daily Deposits
D. Departmental Deposits

Answer: B. Demand Deposits

14: A situation of a very low rate of interest where speculative demand for money becomes infinite is called:

A. Inflationary Gap
B. Deflationary Spiral
C. Liquidity Trap
D. Monetary Squeeze

Answer: C. Liquidity Trap

15: Money that is issued by the order (fiat) of the government is known as:

A. Fiduciary Money
B. Fiat Money
C. Credit Money
D. Bank Money

Answer: B. Fiat Money

16: Which of the following is NOT a primary function of money?

A. Medium of Exchange
B. Measure of Value
C. Standard of Deferred Payments
D. Unit of Account

Answer: C. Standard of Deferred Payments

17: Which of the following is NOT considered a drawback of the barter system?

A. Lack of double coincidence of wants
B. Lack of a common measure of value
C. Lack of divisibility of goods
D. Lack of specialization

Answer: D. Lack of specialization

18: Which of the following is NOT a component of the M1 measure of money supply?

A. Currency held by the public
B. Net time deposits of banks
C. Demand deposits of people in banks
D. Other deposits in the RBI

Answer: B. Net time deposits of banks

19: Which of the following is NOT an example of credit money?

A. Token coins
B. A silver coin from the British period whose commodity value equals its money value
C. Demand deposits in a bank
D. Circulating promissory notes issued by the central bank

Answer: B. A silver coin from the British period whose commodity value equals its money value

20: All of the following are sources of money supply in an economy EXCEPT:

A. The government
B. The central bank (RBI)
C. The general public holding the money
D. Commercial banks

Answer: C. The general public holding the money

21: The evolution of money has passed through various stages. Which of the following is NOT one of these stages?

A. Commodity money
B. Metallic money
C. Barter money
D. Bank money

Answer: C. Barter money

22: Which of the following is NOT an example of Fiduciary Money?

A. Cheques
B. Drafts
C. Currency notes
D. Bills of exchange

Answer: C. Currency notes

23: The M4 measure of money supply includes all of the following EXCEPT:

A. M3
B. Total deposits with Post Office Saving Organisation
C. National Saving Certificates (NSC)
D. M1

Answer: C. National Saving Certificates (NSC)

24: The functions of money overcome the difficulties of the barter system. Which of the following pairings is NOT correct?

A. Medium of Exchange – Solves lack of double coincidence of wants
B. Measure of Value – Solves lack of common measure of value
C. Store of Value – Solves lack of standard of deferred payment
D. Standard of Deferred Payment – Solves problem of borrowing and lending

Answer: C. Store of Value – Solves lack of standard of deferred payment

25: Assertion (A): The barter system faced the problem of a lack of double coincidence of wants.
Reason (R): In a barter system, it was difficult to find a person who simultaneously had what another person wanted and wanted what the other person had.