Money: NBSE Class 12 Economics solutions, answers, notes
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
Long ago, people did not use coins or notes. They exchanged goods directly for other goods. This system was called barter. However, barter had many problems. The biggest issue was the need for a double coincidence of wants. This means if you had shoes and wanted wheat, you had to find a farmer who had wheat and also needed shoes. If the farmer did not want shoes, no trade could happen. Barter also made it hard to decide the value of things. It was difficult to know how many shoes were equal to one cow. Also, storing wealth was hard because goods like vegetables would rot.
To fix these problems, humans invented money. Money is anything generally accepted as a medium of exchange. It has gone through many stages, starting as commodity money, then metal coins, paper notes, and now digital bank money. Money performs four main jobs. First, it acts as a medium of exchange. It solves the double coincidence problem because everyone accepts money for their goods. Second, it is a measure of value. It gives a single price to things, making it easy to compare the cost of milk against the cost of a shirt.
Third, money serves as a standard for deferred payments. This means it helps people settle debts in the future. In barter, paying back a loan was risky because the quality of goods could change. Money keeps its value relatively stable, making borrowing and lending easier. Fourth, money is a store of wealth. Unlike perishable goods, you can save money to use later. This purchasing power lets people plan for the future.
There are different ways to classify money. Full-bodied money is when the metal in a coin is worth the same as the value written on it. Credit money is when the material value is lower than the face value, like paper notes. Legal tender is money the law says must be accepted. Fiat money is issued by government order, while fiduciary money, like cheques, relies on trust between the payer and receiver.
The total amount of money held by the public at a specific time is called the money supply. This includes cash and money in bank accounts. The central bank manages this supply carefully. If there is too much money, prices go up. Sometimes, if interest rates are very low, people keep cash instead of investing it. This situation is called a liquidity trap. It is like money getting stuck in a hole, unable to help the economy grow.
Textual questions and answers
Multiple Choice Questions
1. In India, coins are limited legal tender because coins of 1, 2, 5, 10 are accepted upto maximum sum of—
(a) 100
(b) 1,000
(c) 10,000
(d) 10,00,000
Answer: (b) 1,000
2. Which of the following statements is correct?
(i) Supply of money is a stock concept.
(ii) Supply of money does not include stock of money held by the government.
(iii) Supply of money includes the stock of money by the banking system of a country.
(a) (i) and (iii)
(b) (i), (ii) and (iii)
(c) (ii) and (iii)
(d) (i) and (ii)
Answer: (a) (i) and (iii)
3. Which of the following statements is correct?
(a) Supply of money refers to stock of money held by public at a point of time
(b) Supply of money is a flow variable
(c) Supply of money includes cash reserves of banks
(d) Supply of money refers to bank money.
Answer: (a) Supply of money refers to stock of money held by public at a point of time
4. ‘Medium of exchange’ function of money has solved the barter’s specific problem of:
(a) Lack of double coincidence of wants
(b) Lack of common measure of value
(c) Lack of standard of deferred payment
(d) Difficulty in storing wealth
Answer: (a) Lack of double coincidence of wants
5. Supply of money refers to ________
(a) currency held by the public
(b) currency held by Reserve Bank of India (RBI)
(c) currency held by the public and demand deposits with commercial banks
(d) currency held in the government account
Answer: (c) currency held by the public and demand deposits with commercial banks
6. Demand Deposits include ________ and ________
(i) Saving Account Deposits
(ii) Fixed Deposits
(iii) Current Account Deposits
(iv) Post Office Savings
Alternatives:
(a) (i) and (ii)
(b) (ii) and (iii)
(c) (i) and (iii)
(d) (i) and (iv)
Answer: (c) (i) and (iii)
7. Read the following dialogue between two people—
Sita: I want 1kg of potatoes.
Rani: What will you give in exchange?
Sita: I can give you 2 litres of milk in return for the potatoes.
Rani: I don’t need milk. I want a pair of shoes.
Which of the following problems is being faced by Sita and Rani in their exchange process?
(a) Lack of double coincidence of wants
(b) Absence of common unit of value
(c) Lack of store of value
(d) Lack of standard of deferred payment
Answer: (a) Lack of double coincidence of wants
8. There are two statements given below, about the effect of rise in the general price level of an economy.
P: It will lead to a rise in the value of money.
Q: It will lead to a rise in the demand for money.
Which of these is/are true?
(a) Only P
(b) Only Q
(c) Both P and Q
(d) Neither P nor Q
Answer: (b) Only Q
9. Read the following statements—Assertion (A) and Reason (R).
Assertion (A): Notes and coins are the source of money supply in the economy.
Reason (R): Demand deposits with commercial banks are also a component of money supply.
Choose one of the correct alternatives given below.
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is true but Reason (R) is false.
(d) Assertion (A) is false but Reason (R) is true.
Answer: (b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A).
Very Short-Answer Type Questions
1. Define 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.’
2. What is liquidity trap?
Answer: It is a situation of very low rate of interest where people expect the interest rate to rise in future and consequently bond prices to fall.
3. Define full-bodied Money?
Answer: Any unit of money, whose face value and intrinsic value are equal, is known as full bodied money, i.e., Money Value = Commodity Value.
4. What is barter system?
Answer: Direct exchange of goods against goods without use of money is called barter exchange.
5. What is 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.
6. What is the main function of money?
Answer: 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.”
7. How does money act as a measure of value?
Answer: Money acts as a unit of account or measure of value because the monetary unit is that unit in terms of which value of all goods and services is measured and expressed. The value is expressed as price.
8. In what way does barter system face the problem of divisibility? Give an example.
Answer: The barter system faces the problem of divisibility when trying to exchange goods of unequal 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.
Short-Answer Type Questions-I
1. What are primary functions of money?
Answer: Medium of exchange and measure of value are primary functions because they are of prime importance. Medium of exchange is the basic or primary function of money. Money acts as a medium of exchange or as a medium of payments. The money serves as a common unit of account or a measure of value.
2. 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. For example, face value of ₹ 100 note is ₹ 100, but we would get a much lower value if we sell the note as a piece of paper. Credit cards, bank deposits are other examples of credit money.
3. What are the components of money supply?
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.
4. When the barter system was in use, a merchant had to incur cost in the absence of money. What were those costs?
Answer: Trading costs are costs of engaging in trade. Its two components are search cost and disutility of waiting. Remember, search cost is the high cost of searching for suitable persons to exchange goods and disutility of waiting refers to time period spent on searching for the required person.
5. Explain function of money as a Unit of Account/Measure of Value. How has it solved the related problem of barter?
Answer: The unit of account function means that 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 value of all goods and services is measured and expressed. The value is expressed as price. Money as unit of value makes keeping of business account easy because all business transactions are expressed in money. In this way, money as a unit of account has removed the barter problem of common measure.
The unit of account function means money is the standard for quoting prices. Value of goods and services is measured and expressed as price. Money as unit of value makes keeping business accounting easy because all transactions are expressed in money. This has removed the barter problem of common measure.
Short-Answer Type Questions-II
1. Discuss the secondary functions of money.
Answer: Standard of deferred payment and store of value are called secondary functions because they are derived from primary functions.
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. 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: It means money can be stored as an asset for use in future. It serves as a store 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. Clearly, money is the best form of store of value.
2. “Money is medium of Exchange”. Explain.
Answer: Money came into use to remove the inconvenience of barter especially the problem of lack of coincidence. Money as 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.
It is only an intermediary. The use of money facilitates exchange, exchange promotes specialisation, specialisation increases productivity and efficiency. Money is also called a bearer of options or generalised purchasing power because it provides freedom of choice to buy things he wants most from those who offer best bargain.
3. How does money overcome the shortcomings of a barter system?
Answer: Money has overcome drawbacks of barter system which make 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 medium of exchange solves the barter problem of lack of double coincidence of wants as money has separated the acts of sale and purchase.
(ii) Money as measure (unit) of value or a unit of account solves the barter’s problem of absence of common measure (unit) of value.
(iii) Money as store of value solves the barter problem of difficulty in storing wealth (or generalised purchasing power).
(iv) Money as standard of deferred payments helps to solve the barter problem of lack of standard of deferred payment.
4. Being a proper source of medium of exchange, money accelerates the volume of transaction. Comment.
Answer: Money as 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 has expanded the scope of sale and purchase as it is accepted as medium of exchange.
The use of money facilitates exchange, exchange promotes specialisation, specialisation increases productivity and efficiency. It facilitates exchange of goods and services and helps carry on trade smoothly. The present highly complicated economic system will not exist without money.
5. “Money as a store of value helps to shift purchasing power from present to the future”. Explain.
Answer: It means 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. 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. Clearly, 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.
Long-Answer Type Questions-I
1. Explain any three problems of barter exchange.
Answer: The following are some of the drawbacks or inconvenience of barter exchange:
- 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. In other words, what one person wants to sell and buy must coincide with what some other person wants to buy and sell. ‘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. This is called lack of coincidence of wants which is the main drawback of the barter exchange. Thus there are two trading costs of barter exchange, namely (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 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 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.
2. Give any four advantages of money.
Answer: Although uses of money are manifold yet a few of its important advantages are given below:
(i) Money as 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 has expanded the scope of sale and purchase as it is accepted as medium of exchange.
(ii) Money as measure (unit) of value or a unit of account solves the barter’s problem of absence of common measure (unit) of value. Money serves as a unit of value or unit of account and acts as a yardstick to measure 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.
(iii) Money as store of value solves the barter problem of difficulty in storing wealth (or generalised purchasing power). Moreover, money in convenient denominations (like Indian coins of 1, 2, 5, 10, rupees and currency notes of 2, 5, 10, 50, 100, 200, 500) solves the barter problem of absence or lack of divisibility.
(iv) Money as standard of deferred payments helps to solve the barter problem of lack of standard of deferred payment. Again, it helps to make contracts which involve future payments. Doubtlessly, money helps remove the difficulties of barter system.
3. How is limited legal tender money different from unlimited legal tender?
Answer: 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 maximum sum of ₹ 1000 as per Coinage Bill passed on 11th August, 2011. Beyond this limit, one could refuse payments in these small coins beyond a sum of ₹ 1,000. One can refuse payments by an individual in small coins beyond this limit.
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.
4. What is liquidity trap? Explain with the help of an example.
Answer: Liquidity trap is a situation of very low rate of interest where people expect the interest rate to rise in future and consequently bond prices to fall. So, it becomes totally unattractive to invest money in bonds causing capital loss. People withhold, as inactive balance of any amount of money they have and nothing is invested.
In such a situation, when rate of interest declines to minimum, say 3%, speculative demand for money becomes infinite (perfectly elastic) making the demand curve a horizontal straight line curve parallel to X-axis beyond a point like L in the figure. 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.
5. Explain the components of 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. Only that part of total stock of money which is held by users/holders is included and the remaining part lying with producers/suppliers is not included.
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.
Long-Answer Type Questions-II
1. Discuss in detail the problem of barter system.
Answer: The following are some of the drawbacks or inconvenience of barter exchange:
- 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. In other words, what one person wants to sell and buy must coincide with what some other person wants to buy and sell. There is lack of double coincidence in the wants of buyers and sellers. This is called lack of coincidence of wants which is the main drawback of the barter exchange.
- 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. Absence of a common denominator in order to express exchange ratios creates many difficulties.
- Lack of standard of deferred payment: There is 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 the 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.
- Lack of divisibility: Lack of divisibility of goods makes barter exchange impossible.
2. What do you mean by money? Explain the functions of money.
Answer: Money is anything that is commonly accepted as a medium of exchange. Since general acceptability is the fundamental characteristic of money, therefore, money may be defined as ‘anything which is generally acceptable by the people in exchange of goods and services or in repayment of debts.’
Functions of money are reflected in the following well-known couplet: “Money is a matter of functions four – A medium, a measure, a standard, a store.”
- Money as the Medium of Exchange: 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 the miser). It is only an intermediary.
- Money as a Unit of Account or Measure of Value: The unit of account function means that 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 value of all goods and services is measured and expressed.
- 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. 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 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. Holding money is equivalent to keeping a reserve of liquid assets because it can be easily converted into other things.
3. Explain how money acted as a solution to the problems of barter system.
Answer: Money has overcome drawbacks of barter system. 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 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 intermediary solves barter’s problem of double coincidence of wants.
(ii) Money as measure (unit) of value or a unit of account solves the barter’s problem of absence of common measure (unit) of value. Money serves as a unit of value or unit of account and acts as a yardstick to measure exchange value of all commodities.
(iii) Money as store of value solves the barter problem of difficulty in storing wealth (or generalised purchasing power). Moreover, money in convenient denominations solves the barter problem of absence or lack of divisibility.
(iv) Money as standard of deferred payments helps to solve the barter problem of lack of standard of deferred payment. Again, it helps to make contracts which involve future payments. Doubtlessly, money helps remove the difficulties of barter system.
4. Differentiate between the legal definition and the functional definition of money.
Answer: The differentiation between the legal definition and the functional definition of money is as follows:
Legal Definition of Money: Legal Tender Money—Money that has a legal sanction by the government behind it, is called legal tender or legal tender money. Legal tender or legal money means money under the law of land. It is the money issued by 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.
Functional Definition of Money: It 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. 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 medium of payment, it should be treated as money, no matter what its legal status is.
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
37: (I) A person presents a currency note to the RBI.
(II) The RBI has to pay the person a value equal to the amount printed on the note.
A. I is a contradiction of II.
B. II is a liability that arises from the action in I.
C. I and II are unrelated.
D. I is an example of II.
Answer: B. II is a liability that arises from the action in I.
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.
71. 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.
Money can be classified on the basis of the relationship between its value as money and its value as a commodity. Every unit of money has two values: Face Value, which is the value written on the unit, and Intrinsic Value, which refers to the value of the metal or material contained in the unit of money.
Full Bodied Money: Any unit of money whose face value and intrinsic value are equal is known as full bodied money, meaning Money Value equals Commodity Value. For example, during the British period, silver one-rupee coins had a money value equal to their silver content.
Credit Money: Refers to money whose intrinsic value is much lower than its face value (Money Value > Commodity Value). Examples include a ₹100 note, credit cards, and bank deposits. Credit money is further classified into:
(i) Fiat Money: Issued by the order (fiat) of the government to act as money. People have to accept it in exchange for goods and in discharge of debt as the government has commanded it to be money. Coins and currency notes in India are fiat money, also called legal tender.
(ii) Fiduciary Money: Accepted based on the trust the issuer commands, not on a government order. 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 between parties.
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