Here, you will find summaries, questions, answers, textbook solutions, pdf, extras etc. of (Nagaland Board) NBSE Class 12 (Arts/Commerce) Economics Chapter 7: Money. These solutions, however, should be only treated as references and can be modified/changed.
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.
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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.
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.
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.
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.
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.
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.
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