10.07.

2020
Class 12 Money Lesson 27
Lesson 14

1. 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.

2. Types/Kinds of money [2 marks each]

Ø 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.

Ø 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.

Ø 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.

Ø 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.

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 • Limited Legal Tender
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 be the most economical and convenient method
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.

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- 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.

“Money is a matter of functions four-

A medium, a measure, a standard, a store.”

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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 net 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.