1 What are the Functions of Money?
In order to expand credit, this ratio is required to be
As described in the previous concept, the first and the leading role of
money is to function as a mode of exchange. Barter exchanges become
exceptionally tough in a large economy because of the high prices, people
would have to sustain looking for proper people to exchange their excesses
or surpluses.
Money also functions as a suitable unit of account. The value of all the
commodities and services can be expr essed in monetary terms. If the cost
prices of all goods go up in monetary terms, i.e., there is a general rise in
the cost price degree, the value of money in terms of any good must have
come down – in the sense that a unit of money can now buy less of any
good. We call it a decline or deterioration in the buying power of money.
The barter system has other dearths and deficiencies. It is tough to carry
forward one’s opulence under the barter system. Assume you have an
establishment of rice that you do not wish to utilise entirely. You may
consider this stock of excess rice as follows:
:-An asset that you may want to utilise or sell-off, for obtaining other goods
on some future date.
:-However, rice is a biodegradable item and cannot be stockpiled afar a
definite time frame.
:-Holding the stockpiled rice requires a lot of space. You may have to spend
a substantial amount of time and resources looking for people with a
demand for rice when you wish to interchange your stockpile for
purchasing other goods.
:-This issue can be resolved if the rice is sold for money. Money is
perpetual and its stockpiling prices are also noticeably less. Hence, money
can function as a stock of value for individuals.
:-Wealth can be stockpiled in the form of money for future utilisation.
However, to perform this well, the value of money must be adequately
constant and firm.
:- An cost price degree may abrade the buying capacity of money.
2 what is high power money
High powered money is the liability of the monetary authority of the
country. This is also called the monetary base and is created by the RBI.
High powered money includes currency (notes and coins), deposits with
the government and reserves of commercial banks with RBI. So, to sum up,
high powered money is
H=C+R
Where
H - High powered money
C - Currency
R - Cash Reserves of commercial banks
TOKEN ECONOMIC A token economy is a system of contingency
management based on the systematic reinforcement of target behavior.
The reinforcers are symbols or tokens that can be exchanged for other
reinforcers.
FAIT MONEY A government-issued currency is known as fiat money. It is
not backed by a physical commodity, like silver or gold, but by the
government that declared it. The value of fiat money is determined by the
relationship between supply and demand and the overall stability of the
government. It is not determined by the worth of any commodity backing it.
3 What is a commercial bank? Explain various types of accounts with
commercial banks.
:- Commercial bank is defined as an organisation that accepts deposits and
uses the deposited money to lend or invest it by the general public. Various
types of accounts are:
(a) Current Account Deposits: These are the deposits which can be
withdrawn by the depositor at any time by means of cheque. These
deposits are made by businessman and industrialists who use these
deposits for making business payment. The account in which the money is
deposited is known as Current Account. No interest is paid on these
accounts by the bank.
(b) Savings Account: Savings account or deposit is usually held by
households. It provides chequable facility to the customers. There are
restrictions on the number of withdrawals and interest is paid by the bank.
(c) Fixed Deposits/Time Deposits: These are the deposits which can be
withdrawn only after the passing of a certain time period. These deposits
carry the highest rate of interest. These are not considered demand
deposits which are payable on demand and don't carry cheque facility.
OR
Central bank is the apex institution of a country which controls, supervise,
regulate and organize the financial and monetary system of a country.
Three quantitative measures are:
(a) Bank Rate Policy: It is the rate at which central bank lends money to the
commercial bank. There is a direct relationship between bank rate and
interest rate. When the bank rate increases, interest rate also increases.
This affects the lending capacity of the commercial banks and thus
reduces the money supply.
(b) Cash Reserve Ratio: The fixed percentage or proportion of total
deposits which is to be kept with RBI by commercial banks as cash is
known as CRR. When credit is to be decreased, central bank can increase
this ratio so as to reduce the lending power of banks and when it intends to
expand the credit, it reduces the ratio.
(c) Statutory Liquidity Ratio (SLR): A certain percentage or proportion of the
bank's total deposits must be in the form of liquid assets like gold or cash.
It is known as SLR.
reduced but to reduce the credit; SLR must be increased.
4 Explain the lender of last resort function of the central bank.
:- Lender of last resort: The central bank acts as a lender of last resort by
providing money to its member banks in times of cash crunch. It performs
this function by providing loans against securities, treasury bills and also
by rediscounting bills.
This is regarded as one of the most crucial functions of the central bank
wherein it helps in protecting the financial structure of the economy from
collapsing.
5 3 Important Causes of Deficit in Balance of Payments
:-Some of the major important causes of deficit (disequilibrium) in balance
of payments are : 1. Economic Factors 2. Political Factors 3. Social
Factors.
Deficit in the balance of payments may be caused due to number of
factors.
These factors can be divided into three groups:
1. Economic Factors:
(i) Developmental activities:
Developing countries depend on developed nations for supply of machines,
technology and other equipment. This leads to increased levels of imports,
thereby, resulting in a deficit in the BOP account.
(ii) High rate of inflation:When there is inflation in the domestic economy,
foreign goods become relatively cheaper as compared to domestic goods.
It increases imports which causes a deficit in the BOP.
(iii) Cyclical fluctuations:
When the domestic economy is going through a phase of boom, then
domestic production may be unable to satisfy the domestic demand. It
leads to a deficit in BOP, due to increase in imports.
(iv) Change in Demand:Fall in demand for country’s goods in the foreign
markets leads to fall in exports and it adversely affects the balance of
payments.
(v) Import of Services:
Underdeveloped countries import services from developed countries for
which, they have to pay huge amounts of money. It leads to a deficit in the
BOP.
2. Political Factors:
(i) Political Instability:Political instability may lead to large capital outflows
and reduce the inflows of foreign funds, thus, creating disequilibrium in the
BOP.
(ii) Political disturbances:
Frequent changes in the government, inadequate support to the
government in parliament also discourage inflows of capital. This leads to
a deficit due to higher outflows than inflows.
3. Social Factors:
(i) Demonstration Effect:When the people of underdeveloped countries
come in contact with those of advanced countries, they start adopting the
foreign pattern of consumption. Due to this reason, their imports increase
and it leads to an adverse balance of payments for underdeveloped
country.
(ii) Change in tastes, preferences, fashion and trends:
An unfavorable change for the domestic goods leads to a deficit in the
balance of payments.
6 How is the exchange rate determined under the flexible exchange rate
regime?
:-Flexible exchange rate is determined by the forces of supply and demand
in the international market. The equilibrium exchange rate is determined at
a level where demand for foreign exchange is equal to the supply of foreign
exchange.
• Sources of demand for foreign exchange
(i) Payment of international loans
(ii) Gifts and grants to rest of the world
• Source of supply of foreign exchange
(i) Export to the rest of the world
(ii) Direct foreign investment
(iii) Direct purchase of goods and services by the non-residents in the
domestic market.
7 Distinguish between an autonomous transaction and accommodating
transactions of the balance of payments account.
:-Autonomous tra Accommodating
Autonomous transactions
Autonomous transactions
are independent of the state of balance of
payments account (BOP A/c)
These transactions take place on both current and capital accounts.
These transactions take place on both current and capital accounts.
These items in BOP refer to exchange transactions foreign which are made
independently of the state of the balance of payment, such as profit
motive.
+Accommodating transactions
An accommodating transactions are undertaken to maintain the balance in
BOP account
These transactions take place only on capital account
These items in BOP refer to the transaction which is undertaken to cover
deficit or surplus in autonomous transactions.

8 Differentiate between appreciation and depreciation of domestic
currency.
:-Depreciation of Domestic Currency
2. (i) It is a situation of a rise in exchange rate. (ii)More rupees are needed
to buy one US$. (iii)Cause:Increase in demand for foreign exchange or
Decrease in supply of foreign exchange (iv)Example: Exchange rate rises
from (1 US $ : Rs 60) to (1 US $ : Rs 70)
Appreciation of Domestic Currency
(i) It is a situation of a fall in exchange rate. (ii) Less rupees are needed to
buy one US$. (iii)Cause:Increase in supply of foreign exchange or Decrease
in demand for foreign exchange (iv) Example: Exchange rate falls from (1
US $ Rs 60)to (1 US $ : Rs 50)
9 Defective financing
:- Deficit financing is a policy in which government spending is more than it
receives as revenue. The difference between the government spending and
revenue received is being made by borrowing or minting new funds.
Although the budget deficit may occur for several reasons, the term
generally refers to the deliberate efforts to stimulate the economy by
lowering the tax rate and increasing government expenditure. As we have
understood, what is deficit financing? This article lets us learn its
objectives, causes, advantages, and limitations.
10 What is the relationship between APC and APS?
Average propensity to consume (APC) is the ratio of consumption
expenditure (C) and income (Y), which indicates the average percentage of
income that is spent on consumption. It can be algebraically expressed
as:APC=c/y
Average propensity to save (APS) is the ratio of saving (S) and income(Y),
expressing the average percentage of income that is saved. It is
algebraically written as:APS= s/y
As the income is either consumed or saved, the sum of APC and APS is
supposed to be equal to 1. Thus, the higher the APC, the lower will be the
APS and vice versa.
Explain the relationship between MPC & MPS.
MPS - The marginal propensity to save (MPS) is the portion of each extra
dollar of a households income that's saved. The MPS indicates what the
overall household sector does with extra income, specifically, the percent
of extra income that is saved.
MPC - MPC is the portion of each extra dollar of a households income that
is consumed or spent. It helps to quantify the relationship between income
and consumption.
The marginal propensity to consume (MPC) is the flip side of MPS.
Economic theory tends to support that as income increases, so too does
spending and consumption. Therefore, the MPC and MPS have a inversely
proportional relationship with each other.
Consume MPS = Marginal Propensity to save.
Suppose increase in investment is Rs 1000 and MPC = 0.8. The increase in
national income is in the following sequence: (i) Increase in investment
raises income of those who supply investment goods by Rs 1000. This is
the first round increase. (ii) Since MPC = 0.8, the income earners spend Rs
800 on consumption. This raises the income of the suppliers of
consumption goods by Rs 800. This is second round increase. (iii) In the
similar way, the third round increase is Rs 640 = 800 × 0.8. In this way,
national income goes on increasing round after round. (iv) The total
increase in income is Rs 5000.
13 What is real and nominal GDP? Which one is considered a better
indicator of economic growth?
:-Nominal GDP
-It is the current money value of all the final goods and services produced
by normal residents during year. It can change even when there is no
change in output.
-It is not a true indicator of economic growth. Real GDP is a better indicator
of economic growth because it can be compared with base year GDP.
While nominal GDP cannot be compared to any previous year's GDP.
Nd wala dff
-It is the money value of all the final goods and service: produced by normal
residents in a year calculated at base year prices.
It will change only when there is a change in output of an economy.
It is a true indicator of economic growth of a country.
14 State the various precautions of the product method that should be kept
in mind while estimating national income.
:- Precautions of the Product Method :
(i) Sale and purchase of second-hand goods is not to be included.
(ii) The value of intermediate goods is not to be included as it may lead to
double counting.
(iii) Production for self-consumption should be included.
(iv) Value of services rendered by house-wives/ family members is not to
be included.
(v) Production from illegal activities is not to be included.

11 How is the equilibrium level of income attained through AD and AS

approach?
:-According AD and AS approach, the equilibrium is reached only when
aggregate demand (AD) equals aggregate supply (AS) because at this level
there is no tendency for income and output to change.
The equilibrium is where AD intersects 45 line. At this point, AD = AS.
When AD is more than AS , then the planned inventory would fall below the
desired level. To bring back the Inventory at the desired level, the producers
expand the output More output means more income. Rise in output means
rise in AS and rise in income means rise in AD. Both continue to rise till AD
= AS.
When AD is less than AS, then the planned inventory rises above the
desired level. To clear the unwanted increase in inventory, firms plan to
reduce the output till AD becomes equal to AS.
So, equilibrium takes place only at point , where AD = AS.

11 Using the 'saving and investment' approach explain how is the

equilibrium level of national
:-According to this approach of equilibrium, the equilibrium is reached only
when Investment(I) equals Savings(S) because at this level there is no
tendency for income and output to change.
In the diagram the equilibrium is at E1 where savings intersects investment
curve At this point, I=S.
When S is more than I , then the planned inventory would fall below the
desired level. To bring back the Inventory at the desired level, the producers
expand the output More output means more income. Rise in output means
rise in I and rise in income means rise in S. Both continue to rise till they
reach E1, S=I.
When S is less than I, then the planned inventory rises above the desired
level. To clear the unwanted increase in inventory, firms plan to reduce the
output till S becomes equal to I.
So, equilibrium takes place only at point E1, when S=I.

12 Discuss the mechanism of investment multiplier with the help of a

numerical example.
:-Investment Multiplier refers to increase in national income as a multiple
of a given increase in Investment. Its value is determined by MPC. It is
denoted by 'K' where, ∆y = additional income generated ∆I = additional
Investment.
Multiplier= 1/(1-MPC) = 1/MPS;where MPC= Marginal Propensity to