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Answer.
In olden days, when civilization started, human wants were limited.
Everyone used to produce whatever he/she needed. People were entirely
dependant on themselves for fulfilling their requirements. Hence, no need
for exchange was felt by them.
Gradually, the farming and fishing started, which increased the
requirements of the people. It was not possible for all of them to produce
everything for his needs. Then, specialization and division of labour began.
Everyone began to produce those things with which he had know-how,
experience and advantage. Then they started exchanging their produce and
services with others. This created the need for exchange of goods and
services among the people.
Answer.
In earlier days, when civilization started developing, people’s needs
also increased. They became specialized in producing one or few things, but
they were dependant on other’s products for complete satisfaction of their
wants. Thus, a barter economy was created among people to exchange goods
and services.
Therefore, Barter is the direct exchange of goods and services for
other goods and services. This system is called Barter economy.
Barter system requires two important conditions to be fulfilled:-
1. One must have desire to have a things produced by other.
2. He must be willing to give up a thing he produced in exchange for the
other thing which he desires.
This is called double coincidence of wants.
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3. Lack of divisibility.
Suppose, a man requires a goat in exchange of chicken. How can he
divide the goat in exchange for two chickens?
Answer.
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G.D.H Cole
Money is ‘Something which buys things.’
Seligman says:
‘Money is the thing that possesses general acceptability.’
M2= M1+ Time deposits+ Resident foreign currency deposits. This can
be converted at a nominal rate to be used to settle the payment of debt.
Answer.
Money is the matter of function four:
A medium, a measure, a standard, a store.
Answer.
The essential attributes are as follows:
1. General Acceptability
The essential quality of good money material is that it should be
acceptable in exchange for goods and services.
2. Stability of Value.
The money should be fairly stable in value.
3. Transportability.
The commodity chosen for money material should be light and
durable so that is easily transportable.
4. Storability.
The money material should be stored without depreciation in value.
5. Divisibility.
Money should be divided easily in equal parts to allow for purchase
of smaller units or units of lesser value.
6. Homogeneity.
Money material should be of uniform quality and capable of
standardization.
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7. Cognizibility.
The perfect money is that it should be easily recognized.
8. Maleability.
The commodity selected as money should be capable of being molded
and stamped.
Question 6. Can credit cards, debit cards, and plastic card be regarded as
money?
Answer.
No. These cards are not units of account, a store of value and a
standard of deferred payment. In fact, these cards are a loan to customers
which are issued by the bank with a view to increase purchasing power.
a) Fiat Money
b) Debasement
c) Seigniorage
d) Fiduciary Monetary Standard.
e) Full-bodied money
f) Representative full-bodied money.
Answer.
a) Fiat money
Money whose face value is more than its intrinsic value.
b) Debasement
A reduction in the quantity of precious metal in a metal coin that the
government issues as money.
c) Seigniorage
The process whereby the government gains profit by placing a face
value on a coin or other monetary token that exceeds its intrinsic value.
e) Full-bodied money.
Money whose face value is equal to its intrinsic value.
A) Medium of Exchange.
B) Hedge against Inflation.
C) Units of Account.
D) Store of Value
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6) Fiat Money:
A) Is backed by Gold.
B) Includes currency and gold stored in bank vaults.
C) Is the type of money that has no intrinsic value?
Answers:
1 (B)
2 (A)
3 (D)
4 (B)
5 (C)
6 (C)
Question 10
Describe briefly the various monetary systems?
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Answer.
In the primitive stages of economic development various commodities
like fish, cows, goat, and salt etc. were selected to be used as barter units of
value. They were replaced by uncoined metals which consequently taken
over by standardized coins. Today, paper money and bank deposits are the
major media of exchange
On the basis of evaluation according to the economic needs and
development, the money is generally classified under three main
heads:
1) Monometallism
2) Bymetallism
3) Paper money
1) Monometallism
When the value of monetary unit is fixed and maintained in terms of
one standard metal via gold or silver it is called monometallism.
Under this system, the standard of money unit is gold. It is therefore
gold standard. If the unit of money is only silver it is called silver
standard.
2) Bimetallism
When the standard of metal are two, the system is called bimetallism
standard. In other words under bimetallism standard both gold and
silver are used as material for standard money and ratio of exchange is
fixed between their values.
3) Paper money
Under this system paper currency notes are issued by the central bank.
The value of paper money is maintained by placing restrictions on its
issues, It maybe convertible into gold/coin on demand. The law of the
country requires keeping compulsory reserve in form of gold or
approved foreign exchanges in order to issue the notes within
limitation.
Question 11.
Describe the advantages and disadvantages of paper money
Answer
The paper money has number of advantages over metallic money
which are given as follows:
Advantages
1) Economic precious metals:
Paper is cheaper than precious metals. Moreover cost of paper
printing currency is much less than the cost of minting the
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coins. Paper money has also saved the wear and tear of gold
and silver which was due to their constant use.
2) Elasticity
The quantity of money in circulation can be very easily
increased and decreased in accordance with the need of the
country. This system makes the monetary elastic and stable.
3) Easy portability
Paper currency notes are easily portable. Beside, its portability
it is safer, cheaper and more convenient.
4) Easy in Counting
It can be counted very easily in minimum time and accuracy
5) Easy to recognize
The paper money can be easily recognized.
6) Helpful to government
The government can increase its resources by printing of more
notes whenever required.
Disadvantages
1) Unstable value
There is less stability of value in paper money as a result of
which its value fluctuates rapidly which changes the purchasing
power of money.
2) Danger of inflation
The developing countries adopt deficit financing through the
issuing of paper currency which raises the price level and face
inflation.
3) Difficulties in foreign payment
The other countries are not bound to accept paper currency for
receipt and payment
4) Non durable
Paper currency can be easily mutilated, torn out and destroyed
and so loses its value.
Question 12
What is gold standard? What are different forms of gold standard?
Answer
When the unit of money is exclusively defined by law as a
certain amount of gold of specified weight and fitness, this is called
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gold standard. The other form of money within the same monetary
system is kept at parity with amount of gold.
They are following distinct phases through which the gold
standard has passed:
1) Gold currency standard
2) Gold bullion standard
3) Gold exchange standard
4) Gold parity standard
1) Gold currency standard
When gold serves not only as a standard of value but also
circulate as coins, this is called full gold or gold currency
standard.
Main features of the full gold standard are as follows:
A) Free coinage in gold
B) Legal tender: Gold coins are declared as legal tender
money.
C) Freedom of gold trade: there is no restriction in the trade
of gold
D) Convertibility: All other forms of currency e.g. none gold
coins, paper currency notes can be converted on demand
in to coins at fixed rate. People accept other forms of
currency because its value is equal to the gold coins. The
system could not be maintained after First World War
due to limited supply of gold.
2) Gold bullion standard
Under this system gold coins do not circulate. Actual currency
consisted of paper currency notes and token coins and these
were convertible at fixed rate into gold bars.
Main Features of the gold bullion standard are as follows:
A) Gold coins do not circulate. The actual currency consists
of paper currency notes and token coins which are
convertible into gold bullion.
B) Coinage of gold is not allowed
C) Gold reserve is kept at the central bank
D) No restriction on use of gold. The public can have the
ability to obtain gold and use as well as for export.
3) Gold exchange standard
Under this system arrangement is made to purchase gold drafts
which are convertible in to gold abroad for the central bank.
Gold coins do not circulate within the country the local
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Question 13
“Bad money drives good money out of circulation” Discuss.
Answer
There is a law which governs the circulation of money. In U.K
the queen was very much interested to reform the English
currency and was surprised to see that whatever new coins are
put into circulation, they disappeared. Sir Thomas Gresham was
therefore assigned to investigate into the matter. He explained
reasons of disappearance of new coins from circulation which is
known as Gresham’s law. He said “whenever legal tender coins
of the same face value, But of different weights or degree of
fitness, are in current circulation, the light weight or loose coins
tend to drive the full weight pure coins out of circulation. This
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Question 14.
What to do you mean by value of money? How is it determined?
Answer
The value of money is variously used. Generally it may mean in the
following three ways:
1) Weight and fitness of gold and silver. Value of money may
mean its command over a definite weight and fineness of
gold and silver as is the case under gold and silver standard
respectively.
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The demand for money was well defined by Lord Keynes as the
amount of money that the people of the country wish to hold
either in the form of coins or currency notes or current deposits
in the bank. Money is demanded for the purpose of buying
goods and services. The more the goods and services are to be
bought and sold, the more is the demand for money. So the
demand for money depends on the total value of transactions of
goods and services. But the total production of supply and
goods in the country cannot be increased or decreased within a
short period of time. So the demand for money also remains the
same in a given period.
Question 15
Critically examine the Fisher’s quantity theory of money.
Answer
Ervin Fisher, an American economist put forward the Cash
Transaction Approach to the quantity theory of money. He has stated
that the value of money in a given period of time depends upon the
quantity of money in circulation in the economy. It is the quantity of
money which determines the general price level and the value of
money. Any change in the money supply directly affects the general
price level and the value of money inversely in the same proportion.
In Fisher’s words “Other things remaining unchanged, as the quantity
of money in circulation increases, the price level also increases in
direct proportion and the value of money decreases and vice versa”
for example if the quantity of money in circulation is doubled then
other things being equal the general price will be doubled and the
value of money halved. Similarly if the quantity if money is halved,
the price level will be halved, and the value of money will be doubled.
In Fisher’s cash transaction version money the general price level in a
country, like the prices of commodities, it is determined by the supply
of and demand for money
People demand money not for its own sake. They demand money
because it serves as a medium of exchange. It is used to carry
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Equation of exchange
P = MV + M1V1 or PT = MV + M1V
T
Here, P is the price level
M is the quantity of money
V is the velocity of circulation of M
M1 is the of credit money
V1 is the velocity of circulation of M1
T is the total volume of goods and Trade
Explanation:
M=Rs.2000,
M1= Rs.1000,
V=6,
V1=4,
T=8000 goods.
P=MV+M1V1
T
P= (2000 x 6) + (1000 x 4) = 12000 + 4000
8000 8000
= 16000 = Rs.2 per good.
8000
Thus when the money supply is doubled, the price level is doubled.
i.e., the price of the good rises from Rs.2 to Rs.4 per unit and the value of
money is halved= Rs.2
Figure A)
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Figure B)
Question 16
What is quantity theory of money? What are different approaches of
theory and how they differ from each other?
Answer
It is the theory that nominal income is determined solely by
movement in the quantity of money leading to the equation of
exchange Ms V = PT with V constant.
a) Irving Fisher’s Quantity theory of money suggests that the
demand for money is purely a function of income, and interest
rates have no effect on the demand for money. It also assumes that
economy will always tend to full employment, national income and
the stability of velocity arises from the technological and
institutional framework.
b) Cambridge Cash Balance Approach did not rule out the
effect of interest rate on demand for money assuming that money
function as a medium of exchange that people can use to carry out
transactions which depends on the level of transactions or nominal
income, and money also functions as a store of wealth. This
depends on individual choice and does not rule out effect of
interest rates.
c) Milton Friedman Quantity theory of money suggest that
demand for real balances is determined by wealth or permanent
income, interest rates on different instruments for holding money
and expected inflation.
Multiple choices.
Answers 1. c) 2. a)
Question 17
Define Inflation? What are the causes of Inflation? How can it be
controlled?
Answer.
Inflation is a process in which the price level is rising at a rapid rate
and money is losing its value. In the words of Gardner Ackley, ‘Inflation
may be defined as persistent and appreciable rise in the general level or
average of prices.’ Kent defined inflation as ‘Inflation is nothing more than a
sharp upward movement in the price level.’ Keynes says inflation is ‘Any
rise in the price level, after the level of full employment has been achieved.’
So it can be concluded that Inflation is a persistent rise in prices rather than a
sudden rise in prices.
It may be noted that rising general level of prices does not mean that
all prices are necessarily rising. Even during inflation, the prices of some
goods may remain relatively constant and a few other actually falling.
Therefore, Inflation is a continued upward movement in the general
(average) level of prices. In the words of Milton Friedman, ‘By inflation is
meant a steady and sustained rise in the prices.’
Causes of Inflation.
The causes of inflation are generally grouped under two main
headings:
(A) Demand-pull inflation.
(B) Cost-push inflation.
A. Demand-Pull Inflation
Demand-pull inflation occurs when aggregate demand for goods
exceeds aggregate supply of goods at current prices, thus leading to an
increase in the price level. The factors which bring about an increase in
aggregate demand for goods or rise in the general level of prices are grouped
under two separate headings: (1) factors operating on the demand side, (2)
factors operating on the supply side.
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(1) Factors operating on the demand-side which bring continuous rise in the
general price level:
• Increase in Population.
The rapidly rising population exerts pressure on the demand of
goods and services. If the supply of goods and services fail to match with
the demand, the general price level moves upward.
• Black Money
The money generated through smuggling and tax-evasion raises
the demand for luxury and other goods. Hence it is one of the causes for
raising the aggregate demand for goods and a rise in the general price
level.
B. Cost-push Inflation.
Cost-push inflation occurs when there is an increase in the cost of
production of goods and is not associated with excess demand. The main
causes of cost-push inflation are:
• Profit-push inflation.
If the producers of certain commodities have monopoly over or
near monopoly power in the market, they fix up higher profit margin. The
higher profit margin thus inflates the price level.
• Material-push inflation.
If there is an increase in the prices of some basic materials such
as gas, steel, chemicals, oil etc, which are used directly or indirectly in
almost all industries, it causes an increase in the cost of production and
hence, in the general price level.
• Higher taxes.
If the government levies new taxes and raises the rate of old
taxes, the producers generally shift the burden of the taxes onto the
consumer. The increase in the selling price of the commodity pushes up
the inflationary trend in the economy.
• Import goods.
If the price of the imported goods increases, it also results in the
contribution of inflation.
Remedies of Inflation.
The main measures which are used to control inflation are: 1) monetary
policy, 2) fiscal policy and other measures.
1) Monetary Policy.
Monetary policy is a policy that influences the economy through changes
in the money supply and available credits. Monetary policy is adopted by
central bank of the country. Their measures to control inflation are a)
quantitative control and b) qualitative control. This includes open market
operations, variation in bank rates, credit rationing, varying reserve
requirements, varying margin requirements and consumer credit
regulations.
2) Fiscal Policy.
Fiscal policy is the deliberate change in either government spending or
taxes to stimulate or slow down the economy. It is the budgetary policy
of the government relating to taxes, public expenditure, public borrowing
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2) Other measures.
Other measures which are helpful in controlling inflation are
a) Price report program.
b) Provision of subsidies.
c) Arrangement of easy availability of goods on hire-purchase.
d) Imposing direct control on price of essential items.
e) Rationing of essential consumer goods.
Question 18.
Write short notes:
) Deflation
) Reflation
) Stagflation
) Disinflation.
Answer
3) Stagflation: the advance countries of the world since 1960 are facing
twin problems of rising prices and unemployment. The term
‘stagflation’ was coined to explain the co-existence of inflation and
employment. In the words of Samuelson ‘Stagflation involves
inflationary rise in prices and wages at the same time. The people are
unable to find jobs and firms are unable to find customers for what
their plants can produce.’ In the words of Michael Swan ‘Stagflation
can be described as a contraction or stagnation of a nation’s output
accompanied by rise in the price level.’
Question 19
Multiple Choice Questions.
Answers:
1 (A) 2 (B) 3 (C) 4 (C) 5 (C) 6 (E) 7 (B) 8 (B)