Cee SS ACADEMY DIPLOMA IN ESTATE AGENCY COURSE (PART I) SUBJECT: PRINCIPLES OF ECONOMICS. Past Year Question & Answers 2001 - 2012 Topic 16 MONEY SUPPLY & FINANCIAL SYSTEMSrncnes oF economies one 16 Money: 2oI1-Gueston 4B) | ©) Elaborate the four (4) functions of the money in an eccnomy. (8 marks) = Medium of Exchange -A medium of exchange Is an lem that buyers ive to sellers when they want to purchase goods ond services. A medium of exchange i onything that & readiy acceptable os poyment = Unit of Account - A unit of account is tha yardstick people use to post prices ond record debts Store of Value - A stove of value is an item that people can use to transfer pucchasing power from the present fo the future. Slander for deferted payment - When money & genecaly accepted (95 a medium of exchange end a unit of value, it natualy becomes {he unit in terms of which deferted oF fulure parments are stated. To become a satisfactory standard of defered payments, money must rmointain 9 constant value through time: ifs velue increares through time fe., during the period of foling price lev) it wil benaft the ‘cecios at the cost of debtos iis value fal fe. during the period of ‘sing price level) it wal benefit he debtors at the cost of erection. ronaveston 70) | 1 b) Differentiate the function of commercial banks and central bank, (10 marks) Commercial Bonk 1) Acceptance of Depest i). Giving loans ondinvesting i) Provision of cheque payment Iv) Provide other services ke ATM, cata box. adtice service ate Cental tant 1) sues coins ond notes and protect value of curency i) Actos Government's banker and foncial advisor 1) Act ostonder of ast resort iv] Promote financial stabity and a heathy financial conetion Tolsied & Researched orRemecoli Academy ———~—~S*~*~*~*~*~S~*« GOT PSsrinewts oF economies one 16 MONEY SUPPLY & RMANCIAL SYSTEMS ston 716) i = 6) With reference to conventional financial institution why do lenders need payment of interest? (10 marks) |) Thelenders have soctficed thek curentiquy. Such sacrifice to ‘warrant them interest cate 1) Thelendes ore facing uncertointy ond The potential lose the ‘copital, hence interest is essontiol iy) The lenders have to deal with inflation. An extra payment in form of intecest gives the lender to recover the fost in form of iat. b) Why are borrowers willing to pay interest? (10 marks) 1) Consumer or households - The lender pay for them in advance but the orower ir poying in instalment, hence the interest payable is cperopriate. A group producers If the borrowers did not take the loon the lenders would have invested in some actives that generate futur inflow for the lenders [excmple R & 0). To make the loan cthactve the borrowers poy interest Bonk & Financial istitution = borrows money from publ ond pay interest os retum of the fund used, MThe Government = Even the Government tend fo borrow fund in form ‘of bond ond treasury bils. Interest poid because the return gain from these loans wal provide greater impact to economy. E i ©) Wilte short notes about demand for money and Keynes' liquidity rap? (10 marks) ‘he lauidly trop may be defined os the set Up of pons on the lquidly preference cuve where the percentage change in the demand for money, oF AM/M in ‘esponve 10.@ percentage in the rate of interet oii, approaches infin. In other word, there wil be a iquicly trap when the demand for money becomes petfecly elastic at @ particu low role of interest. Refer To: In which the L2 cule epiels the iquicly preference Under the specucive motive, af vorving rates oF interest ‘Colioted Researched for Ramscoll Academy ———~—S~S~*«S gEranciuts oF tconomies one. [MONEY SUPPL XFINANCIAL SYSTEMS Fe obvious, from the diogtam.thot_ a high interest rate (208) there & very Ita demand for z money under the Eu specuative motive. E e As the interes! rote moves 2 Luawaty ap lower ond lower. Ine é demand for specuiative ur ~ ce boiances tecomes larger _, 29 Loxger unit at 2h becomes infinitely elastic, le. any increase inthe money supply will be hed {ile cath, Dolancer by the people, qty Pretorence This stuation is called Squidily trop. The trap Is depicted in the fqudily preference ‘curve (LP), where the sope of the tangent fo the curve becomes horzontal {he ity two 1. At 6 very low rate of inleest on oltemative assets in the financial marke, the ‘opportunity cost of olcing ile Balance fends fo be the minimum, 2. When interest rates come down to @ minimum, the oppertunly cod of hoarding idle money & expected forse inthe future rather than dectne further. ‘As such people ae induced fo hootd os idle balonees ol the ecdlione! money Supply made available a this minimum rate of interest This makes the demand for money perfectly elastic. Ase result, any odaltional ‘money supply falls fo bring down the rate of interest further. The liquidity ttap is also important, party, Because itis thoucht to concen sivotions in which the monetary officials ose control over invesiment in eal Capital goods vio the rate of interest In the Keynesion view, its the speculative demand for money tha! introcuces a ‘dynamic element in the process of general price movemienls ond in the volume fof employment ond output through a relationship between tre curent ond perspective rates of interest and the profitabilly of investment. It nos bean observed, nowever, that Guting Intlatonary conctions i tne ‘economy, the transactions demand for money tends tor When prices in general ore ring, people find 2 decreasing valve of money. so they may tend! 10 hold mote real asses rather than money. Hence ther volume of ‘ranscctions wil is, ‘Colated & Researched Ramicoli Academy Page SofINCIUES OF ECONOMICS tone 16 MONEY SUPPLY & FINANCIAL SYSTEMS {Agoin. In view ofthe ring pices. thei routine oxpancice will ko se. As such, ung inflation, people wil be induced fo held more active balances for transactions purposes, le.. fo spend quickly. Dung deflation, apparently. the transactions cemand for money wil fend to decreare. b) The equation of demand and supply of money determine interest ‘equilibrium. Explain. (10 marks) The money market is the market for money. In the money market, the {good that is traded is money and the price of the good is the interest Fale. The money supply is fixed by the central bank. That i, the money supply curve is vertical end does not change for different interest rates. ‘The money demand curve plots the quantity of money that the pubic wants fo hold a! different interest rates. itis downward sloping (Le. the public wants fo hold less money at higher interest rate) because of liquidity preterence people prefer holding their weaith in the form of money because money s the most quid asset. The benefit of holding weatth in the form of money is its liquicity. But thete is a cost of holding money "the interest foregone in holding wealth in the form of money rather than in other interest-bearing casiels”, Therefore, at @ higher interest rate, the costs of holding money are aigher. and thus people are wiling to hold less money. the money demand curve is downward sloping. ‘The money market equilloium is given by the intersection of the money demand and money supply curves. The market equilibrium is at E and the equilbrium interest rate is *. -— [toes se Mendy demand ° ‘ant tedy——_Ovaviyomoney Bankesrome 16 ‘Any impact on money demand cause the demand cure to move up or down, in ths case an increase in money demand causes the interest rate to increose ond vice versa, « ‘Quant fedby Quantity ofmoney Bank Negara ‘Any impact on money supply cause the supply curve to move up or down. In this case an increase in money supply cause the interest rate to decrease ‘ond vice versa. 0 Genny faedby— uanty frmaney Bank Negara