1 What are the Functions of Money? It is known as SLR.

In order to expand credit, this ratio is required to be

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

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