Chapter – 2

Money And Banking

In this post, we have given the Important Questions of Class 12 Economics Chapter 2 (Money And Banking) in English. These Important Questions are useful for the students who are going to appear in class 12 board exams.

Board	CBSE Board, UP Board, JAC Board, Bihar Board, HBSE Board, UBSE Board, PSEB Board, RBSE Board
Textbook	NCERT
Class	Class 12
Subject	Economics
Chapter no.	Chapter 2
Chapter Name	(Money And Banking)
Category	Class 12 Economics Important Questions in English
Medium	English

Chapter 2 MONEY AND BANKING

Very Short Answer Question

Q1. Define money.

Ans. Money may be defined as anything which is acceptable as a medium of exchange.

Q2. What determines money multiplier?

Ans. Legal reserve ratio

Q3. State any two components of M1 measure of money supply.

Ans. Currency with public and demand deposits with banks.

Q4. What are demand deposits?

Ans. Demand deposits are the deposits which are payable by the banks on the demand by the customers at any time.

Q5. Define Barter system.

Ans: Barter system of exchange is a system in which goods are exchanged for goods.

Q6. What is meant by double coincidence of wants?

Ans: Double coincidence of wants means that goods in possession of two different persons must be useful and needed by each other.

Q7. Define commercial bank.

Ans: Commercial bank is a financial institution which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit.

Q8. Define money multiplier/credit multiplier/deposit multiplier.

Ans: When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.

Q9. Define central bank.

Ans: The central bank is the apex institution of a country’s monetary system. The design and the control of the country’s monetary policy is its main responsibility. India’s central bank is the Reserve Bank of India.

Q10. What will be the effect of a rise in bank rate on the money supply?

Ans: Money supply will reduce.

Short Question Answer

Q1. Give meaning of money supply. State its components.

Ans. Money supply may be referred as the total stock of money of various kinds at any particular point of time held by the public. Following are the main components of money supply –

• Currency with public – Currency held public means coins and currency notes with the public outside the bank.
• Demand deposits with banks – Demand deposits are the deposits which can be withdrawn at any time by writing cheques.

Q2. Explain the ‘medium of exchange’ function of money.

Ans:  Money when used as a medium of exchange helps to eliminate the basic limitation of barter trade, that is, the lack of double coincidence of wants.

• Individuals can exchange their goods and services for money and then can use this money to buy other goods and services according to their needs and convenience.
• Thus, the process of exchange shall have two parts: a sale and a purchase.
• The ease at which money is converted into other goods and services is called “liquidity of money”.

Q3. Explain the working of money multiplier with the help of a numerical example.

Ans. Money multiplier refers to the process of creation of credit by the commercial banks, with the help of initial deposits made by the public and legal reserve ratio (LRR).

Money Multiplier = 1/𝐿𝑅𝑅

Suppose there is initial deposit of Rs.1000 crores and LRR is 10%, then

Money Multiplier = 1/10%= 10

Total deposits = Initial deposits X 1/𝐿𝑅𝑅

Credit Creation = 1000 X 10 = Rs.10000 Crore.

Q4. Explain bankers bank function of Central Bank.

Ans. Central Bank act as banker to all other banks in the country just as commercial banks act as banker to general bank public. It performs following function –

• Making policies and regulation for commercial banks
• Maintaining cash reserve as deposit by the commercial banks
• Providing financial assistance to commercial banks during crisis

Q5. Explain the role of repo rate in reducing money supply.

Ans. Repo rate is the rate of interest at which Central Bank lends money to commercial banks for short period. Raising repo rate makes borrowing by commercial banks costlier. So these banks are forced to raised their lending rates. Since borrowing becomes costly for people, they borrow less. Banks therefore create less credit.

Q6. Discuss briefly the credit controller function of Central Bank.

Ans. The primary objective of credit control is to remove causes responsible for instability in price fluctuations which in turn are related to the supply of money. By controlling credit, the Central Bank can exercise an effective control over economic activity and mobilise it in the desired direction. Central Bank regulates the volume and use of credit by using quantitative and qualitative tools.

Q7.What is a ‘legal tender’? What is ‘fiat money’?

Ans:

Legaltender:

• Legally, money is anything proclaimed by law as a medium of exchange.
• Paper notes and coins (together called currency) is money as a matter of law.
• Nobody can refuse its acceptance as medium of exchange.

FIAT Money: It is defined as a money which is under the ‘FIAT’ (order/authority) of the government to act as a money.

Q8. What role of RBI is known as ‘Lender of last Resort’?

Ans:

• As banker to the banks, the central bank acts as the lender of the last resort.
• In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances.
• The central bank assists such banks through discounting of approved securities and bills of exchange.

Long Answer Questions

Q1. What are the main functions of money? How does money overcome the shortcoming of a barter system?

Ans. Money has overcome the shortcoming of a barter system in the following manner:

• Medium of exchange – Under barter system, there is lack of double coincidence of wants. With money as a medium exchange individuals can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences. A buyer can buy goods through money and a seller can sell goods for money.
• Measure of value – Under barter system, there was no common measure of value. Money has also solved this difficulty. Money measures the value of economic goods. Money works as a common denominator into which the values of all goods and services are expressed. When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.
• Store of value – Under barter system it is very difficult to store wealth for future use. Most of the goods are perishable and their storage requires huge space and transportation cost. Wealth can be conveniently stored in the form of money. Money can be stored without loss in value. Money can easily be stored for future use.
• Standard of deferred payments – Under barter system, transactions on deferred payments are not possible. With money, the debtors make a promise that they will make payments on some future dates. In those situations money acts as a standard of deferred payments. It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.

Q2. Explain briefly the working of money multiplier.

Ans: Yes, commercial bank acts as a ‘Creator of money’ in the economy. It can be explained with the help of Credit creation process:

• Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply “banks’. Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing cheque. The one who receives payment deposits the same in his deposit account.
• Suppose initially people deposit Rs 1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank.
• Let us now explain the process, suppose the initial deposits in banks is Rs 1000 and the LRR is 10 percent. Further, suppose that banks keep only the minimum required, i.e., Rs 100 as cash reserve, banks are now free to lend the remainder Rs 900. Suppose they lend Rs 900. What banks do to open deposit accounts in the .names of the borrowers who are free to withdraw the amount whenever they like. Suppose they withdraw the whole of amount for making payments.
• Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposit in banks by Rs 900. It is 90 per cent of the initial deposit. These deposits of Rs 900 have resulted on account of loans given by the banks. In this sense the banks are responsible for money creation. With this round increase in total deposits is now Rs 1900 (=1000 + 900).
• When banks receive new deposit of Rs 900, they keep 10 per cent of it as cash reserves and use the remaining Rs 810 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise, but by a smaller amount of Rs 810. It is 90 per cent of the last deposit creation. The total deposits now increase to Rs 2710 (=1000 + 900 + 810). The process does not end and continues till total deposit

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