Class 12 Economics Long Questions With Answers - Money And Banking

Q.1. Define money. Explain its main functions.
Ans. Money can be defined as a generally acceptable medium that can be exchanged for goods and services, and can be used as a measure and store of value.
The following are the important functions of money:
(i) Medium of Exchange: Money acts as an intermediary in the exchange transactions of goods and services. Money solves the problem of double coincidence of wants by acting as a medium of exchange for all goods and services.
(ii) Unit of Value: Money acts as a convenient unit of account. The value of all the goods and services can be expressed in monetary units. Money as a unit of value helps in measuring the value of exchange for various goods and services.
(iii) Store of Value: Money is not a perishable item and its storage costs are also considerably low. Moreover, it is acceptable to anyone at any point of time. Thus, money acts as a store of value for individuals.
(iv) Standard of Deferred Payments: Money acts as standard in terms of which future or deferred payments are stated because money maintains a constant value over a period of time.

Q.2. What is meant by the supply of money? Discuss the factors which determine the supply of money.
Ans. Money supply refers to the amount of money, which is in circulation in an economy at any given point of time.
Following factors determine the money supply:
(i) Monetary Standard: Money supply is affected by the monetary standard. If gold standard is adopted, there will be less supply of money. On the other hand, if paper currency system is adopted, money supply can be increased on the basis of demand.
(ii) Production Volume: Volume of production also determines the money supply. If the level of production is high, the money supply will be more.
(iii) Monetary Policy: Monetary policy of the government also affects the money supply. If the Central Bank increases the Cash Reserve Ratio there will be contraction in money supply.
(iv) Fiscal Policy: Fiscal policy of the government determines the money supply. If government prepares deficit budget, money supply will increase.
(v) Other Factors: Banking habits, velocity of money, liquidity preference and the volume of money multiplier also determine the supply of money.

Q.3. How does central bank control credit creation by commercial banks through open market operation? Explain.
Ans. Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. The central bank sells government securities to commercial banks and general public in a bid to correct the situation of inflationary gap or excess demand. This decreases the stock of high powered money in the economy. As a result, the purchasing power of the people declines. Similarly, the central bank purchases government securities from commercial banks and general public in a bid to correct the situation of deflationary gap or deficient demand. This increases the stock of high powered money in the economy. As a result, the purchasing power of the people increases.

Q.4. Explain any two methods of credit control used by Central Bank.
Ans. Methods of credit control used by central bank are as follows:
(i) Bank Rate: Bank rate is the minimum rate at which the central bank discounts the first class bills of exchange and provides credit to the commercial banks. The central bank increases the bank rate to correct the situation of inflationary gap or excess demand in the economy. Higher bank rate reduces the lending capacity of the commercial banks as they get funds at a higher interest rate from the central bank.
Consequently, money supply contracts in the economy as the public borrows less at high rate of interest. Similarly, the central bank decreases the bank rate to correct the situation of deflationary gap or deficient demand in the economy. Lower bank rate increases the lending capacity of the commercial banks as they get funds at a lower interest rate from the central bank. Consequently, money supply expands in the economy as public borrows more at low rate of interest.
(ii) Open Market Operations: Open market operation is the policy of the central monetary authority to sell and buy the government securities in the market. The central bank sells government securities to commercial banks and general public in a bid to correct the situation of inflationary gap or excess demand. This decreases the stock of high powered money in the economy. Similarly, the central bank purchases government securities from commercial banks and general public in a bid to correct the situation of deflationary gap or deficient demand. This increases the stock of high powered money in the economy.