Economics: Role of Money

Questions and Answers

What is the fraction called that is fixed by the central bank and is related to credit creation?

Legal Reserve Ratio (LRR)

What happens when a bank accepts cash from a customer and deposits it under the customer's name into their account?

Primary Deposit

What is considered as a secondary or derivative deposit?

When a bank grants loans to a borrower (correct)

When a bank accepts cash from a customer

When a bank reduces the credit multiplier

When a bank holds excess reserves

Every financial institution or bank is required to hold a certain amount of money as a reserve to ensure proper ____________.

liquidity Signup and view all the answers

What is the primary aim of the central bank?

Stabilize the currency and economy while limiting inflation. Signup and view all the answers

What is a key feature of the classical paradigm in macroeconomics?

Market Flexibility Signup and view all the answers

Classical economists advocate for minimal government intervention in the economy.

True Signup and view all the answers

According to Robertson's definition, how is money defined?

Anything which is widely accepted in payment for goods Signup and view all the answers

_______ occurs when individuals choose not to work at the current wage rate and under the prevailing conditions in the labor market.

Voluntary Unemployment Signup and view all the answers

In the barter system, the lack of a coinciding wants between the buyer and seller could lead to difficulties in the exchange.

True Signup and view all the answers

Money was introduced to overcome the difficulties of the ______ system.

barter Signup and view all the answers

Match the following types of money with their descriptions:

Commodity money = Includes metallic coins with face value equal to intrinsic value Representative money = Includes coins and paper money with intrinsic value less than face value Legal tender money = Must be accepted by law for payment Optional money = Not legally required to be accepted for payment Signup and view all the answers

What results from an increase in government spending or a tax reduction in the IS-LM framework?

A rightward shift in the IS curve, elevating national income and interest rates. Signup and view all the answers

What is the impact of a decrease in government spending or a tax increase in the IS-LM model?

A leftward shift in the IS curve, resulting in diminished national income and interest rates. Signup and view all the answers

Describe expansionary monetary policy within the IS-LM framework.

Increasing money supply, leading to a downward shift in the LM curve, lower interest rates, and potentially higher national income. Signup and view all the answers

Explain contractionary monetary policy in the IS-LM model.

Decreasing money supply, causing an upward shift in the LM curve, higher interest rates, and potentially decreased national income. Signup and view all the answers

What is the primary limitation of the IS-LM model?

Its static nature, focusing on short-term analysis and overlooking time lags in policy implementation. Signup and view all the answers

Name a noteworthy drawback of the IS-LM model related to its assumptions.

Reliance on unrealistic assumptions such as a closed economy, fixed money supply, and static investments. Signup and view all the answers

What entity is responsible for managing monetary policy and regulating banks?

Central bank Signup and view all the answers

Governments are responsible for controlling monetary policy in a country.

False Signup and view all the answers

What are the primary goals of central banks when managing monetary policy?

controlling inflation, stabilizing currency value, promoting economic growth Signup and view all the answers

Central banks manage a nation's foreign exchange reserves to stabilize the currency's value and intervene in the foreign exchange market if necessary. They also supervise and regulate ______.

commercial banks and financial institutions Signup and view all the answers

Match the following entities with their respective responsibilities in the economy:

Central Bank = Manages monetary policy, regulates banks, controls money supply Government = Controls fiscal policy, taxation, government spending Signup and view all the answers

Study Notes

Money

Definition: Money is the commonly accepted medium of exchange, occupies a unique place in an economic system, and is needed for various transactions undertaken by people and the government.
Evolution:
- Derived from the name of Goddess Juno Moneta of Rome
- Initial stage: Animal was used as money, gradually replaced by metallic money, then coins, paper money, and credit money

Difficulties of the Barter System

Lack of coincidence of wants: Buyer and seller must have a coincidence of wants, which is difficult to achieve
Lack of store of value: Goods are perishable, require huge space and heavy transportation costs
Lack of divisibility of commodities: Not all commodities are divisible, making exchange difficult
Lack of common measure of value: No common measure of value makes exchange difficult
Difficulty in making deferred payments: Future exchange involves difficulties, such as changes in value or quality of commodities

Types of Money

Commodity money and representative money
- Commodity money: Face value and intrinsic value are the same (e.g., metallic coins)
- Representative money: Face value and intrinsic value are different (e.g., coins and paper money)
Legal tender money and optional money
- Legal tender money: Must be accepted by law (e.g., coins and paper money)
- Optional money: Not compulsory to accept (e.g., cheques)
Metallic money and paper money
- Metallic money: Made of metals like silver, nickel, and steel (e.g., coins)
- Paper money: Printed on paper (e.g., currency notes)
Standard money and token money
- Standard money: Face value and intrinsic value are the same (e.g., gold standard)
- Token money: Face value is higher than intrinsic value, not convertible (e.g., Indian rupee)
Credit money: Bank deposits that are repayable on demand and can be transferred through cheques

Supply of Money

Stock concept: Money supply can increase or decrease over time
Influence on economy: Affects interest rates, credit availability, investment, output, national income, and employment
Components of money supply:
- Currency issued by the central bank
- Demand deposits created by commercial banks

Demand for Money

Refers to the total amount of money individuals, businesses, and governments are willing to hold in cash or easily accessible forms
Types of demand for money:
- Transactional demand: For everyday economic activities
- Precautionary demand: For unexpected events
- Speculative demand: Driven by investment foresight and market perceptions

Functions of Money

Primary functions:
- Medium of exchange
- Measure of value
Secondary functions:
- Store of value
- Transfer of value
- Standard of deferred payments
- Money creation or credit creation

Money Creation or Credit Creation

Based on the creation of credit by commercial banks
Banks use a part of their customer deposits to offer loans or lend money on credit
Terms:
- Primary deposits: Cash deposited by customers
- Secondary or derivative deposits: Amount granted as loans to borrowers
- Excess reserves: Amount above the reserve requirements set by the authority
- Credit multiplier: Ratio of change in secondary deposits to change in primary deposits
- Money multiplier or credit multiplier: Influence of the central bank on money supply by modifying reserve rates

Integrating Money and Capital Markets

Money market:
- Platform for short-term borrowing and lending of funds
- Features: Short-term instruments, high liquidity, low risk, regulated market, competitive interest rates, variety of financial instruments
- Functions: Makes short-term borrowing and lending easier, keeps the financial system running smoothly, sets short-term interest rates, sets a standard for other financial instruments, helps control risk, helps with monetary policy
Commodity market:
- Platform for buying and selling commodities
- Features: Standardization, price discovery, low transaction costs, leverage, volatility, hedging, speculation
- Functions: Price discovery, risk management, price stabilization, liquidity, investment, market information
IS-LM model:
- A macroeconomic tool that shows the interaction between interest rates and production within the money market
- Derived from "Investment Savings" and "Liquidity Preference-Money Supply"### IS-LM Model
Also known as the Hicks-Hansen Model
Explains the impact of changes in market preferences on market interest rates and GDP in equilibrium
Components:
- Monetary and fiscal policy
- Liquidity preference
- Balance between investment and saving

Monetary Policy

Involves the central bank's management of the money supply and interest rates to achieve macroeconomic goals
Plays a pivotal role in influencing economic stability and controlling inflation

Fiscal Policy

Encompasses government decisions on spending and taxation, directly impacting aggregate demand
Serves as a potent tool for policymakers to navigate economic conditions and stimulate growth

Liquidity Preference

Reflects individuals' inclination to hold cash rather than invest it
This psychological aspect influences economic decisions and plays a role in shaping monetary policy

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Description

This quiz covers the significance of money in modern economic life, its definition, and its importance in daily transactions. Learn about the role of money in an economic system and its impact on society.