5)CENTRAL BANK, MONEY DD&SS, RBI & UTILITY.pdf

Central Bank
By
Dr. Mahendra Parihar
Associate Professor,
MPSTME, NMIMS Mumbai

Central Bank
“It is a bank of banker”
-- Samuelson
“Bank which has monopoly over note issue”
-- Vera Smith
“Central bank is the government’s bank”
-- Sayers

Central banking
“An institution charged with the responsibility of
managing the expansion and contraction of the volume
of money in the interest of general public welfare”
Prof. Kent
“One which constitute the apex of the monetary and
banking structure of its country”
Prof. M.H. De Kock

CENTRAL BANK:
The Central Bank is the apex bank in the country. It is called by different names in
different countries. It is the Reserve Bank of India in India, the Bank of England in
England, the Federal Reserve System in America, the Bank of France in France, etc.
A central bank has been defined in terms of its functions.
According to Vera Smith, “ The primary definition of central banking is a banking
system in which a single bank has either complete control or a residuary monopoly
of note issue”.

FUNCTIONS OF A CENTRAL BANK
 REGULATOR OF CURRENCY
 BANKER, FISCAL AGENT AND ADVISOR TO GOVERNMENT
 CUSTODIAN OF CASH RESERVES FOR COMMERCIAL BANKS
 CUSTODY AND MANAGEMENT OF FOREIGN EXCHANGE RESERVES
 LENDER OF THE LAST RESORT
 CLEARING HOUSE FOR TRANSFER AND SETTLEMENTS
 CONTROLLER OF CREDIT
 OTHER FUNCTIONS i.e. developing a strong banking system, supervision of
commercial banks, regulation of branch expansion, etc.

CENTRAL BANK AS A CONTROLLER OF CREDIT:
OBJECTIVES:
 TO STABLISE THE INTERNAL PRICE LEVEL
 TO STABLISE THE RATE OF FOREIGN EXCHANGE
 TO PROTECT THE OUTFLOW OF GOLD
 TO CONTROLL BUSINESS CYCLE
 TO MEET BUSINESS NEED
 TO HAVE GROWTH WITH STABILITY etc.

METHODS OF CREDIT CONTROL
QUANTITATIVE METHODS:
 BANK RATE OR DISCOUNT
RATE POLICY
 OPEN MARKET OPERATION
 VARIABLE RESERVE RATIO
i.e. CRR & SLR
QUALITATIVE OR SELECTIVE
CREDIT CONTROL:
 REGULATION OF MARGIN
REQUIREMENT
 REGULATION OF CONSUMER
CREDIT
 RATIONING OF CREDIT
 DIRECT ACTION
 MORAL SUASION i.e. request,
informal suggestion etc.
 PUBLICITY

MONEY: Demand & Supply
By
MPSTME,
NMIMS Mumbai

Money
Money is very much part of our daily functioning
and therefore we are all very familiar with it.
Crowther in his book, ‘An outline of money’ says
“Money can be anything that is generally
acceptable as a means of exchange and that at
the same time act as measure and store of
value”.
According to D. H. Robertson “Money is any thing
which is widely accepted in payment for goods or
in discharge of other kinds of business
obligations”.
Walker tells us by defining money as “Money is
what money does”.

Functions of Money:
Money through its basic functions helped us to overcome the problems of barter system.
The important functions of money are as follows:
 Medium of exchange
 Measures of value
 Store of value
 Standard of deffered (future) payments
 Transfer of value
 Equalization of marginal utilities/productivities
 Measurement and distribution of national income
 Basis of credit
 Increase in productivity of capital
 Liquidity of capital
 Utilization of resources etc………..

SUPPLY OF MONEY
Money supply refers to the stock of money held by people in
spendable form.
In other words, the term money supply refers to the total stock of
domestic means of payment owned by the public (private individuals
and business firms) in a country. This definition includes money held by
the public and in circulation but it does not include money held by the
central Bank, Commercial Banks and the State treasury because they
are money-creating agencies.

RBI’s Measures of Money Supply
In India Reserve Bank of India uses four alternative measures of money supply called
M1, M2, M3 and M4. Among these measures M1 is the most commonly used measure of
money supply because its components are regarded most liquid assets. Each measure is
briefly explained below.
(i) M1 = C + DD + OD.
Here C denotes currency (paper notes and coins) held by public, DD stands for demand
deposits in banks and OD stands for other deposits in RBI.
(ii) M2 = M1 (detailed above) + saving deposits with Post Office Saving Banks
(ii) M3= M1 + Net Time-deposits of Banks
(iii) M4 = M3 + Total deposits with Post Office Saving Organisation
In fact, a great deal of debate is still going on as to what constitutes money supply. Savings deposits
of post offices are not a part of money supply because they do not serve as medium of exchange due
to lack of cheque facility. Similarly, fixed deposits in commercial banks are not counted as money.
Therefore, M1 and M2 may be treated as measures of narrow money whereas M3 and M4 as measures
of broad money.

The Demand for Money
The demand for money is the quantities of
money people are willing and able to
hold at alternative interest rates, ceteris
paribus.
A portfolio decision is the choice of how
(where) to hold idle funds.

 Classical Approach:
David Hume, J.S. Mill, Irving Fisher, etc
MV = PT or Md= PT/V
 Neo-classical Approach:
Alfred Marshall and A.C. Pigou.
Md= KY

The Demand for Money (Keynesian
Approach):
 Although holding money provides little or no interest, there are reasons for
doing so:
– Transactions demand.
– Precautionary demand.
– Speculative demand.

Transactions demand for money – Money held for the
purpose of making everyday market purchases.
Precautionary demand for money – Money held for
unexpected market transactions or for emergencies.
Speculative demand for money – Money held for
speculative purposes, for later financial opportunities.

Why Hold money
 Economists have since identified four factors that influence the three
Keynesian motives for holding money
 The price level
 Income
 The interest rate
 Credit availability

The Demand Schedule for Money
13-28
Quantity of money (in $ billions)
20
18
16
14
12
10
8
6
4
2
100 200 300 400
Transactions
demand
A. Transactions demand
20
10
100 200
Precautionary
demand
B. Precautionary demand
20
10
100 200 300 400 500 600 700 800 900 1,000
Speculative
demand
C. Speculative demand
The Three Demands for Money

Total Demand for Money
13-29
20
18
16
14
12
10
8
6
4
2

200

0
400
600
800
1,000
1,200
1,400
1,600
1,800
Total demand
for money
This is the sum of the transaction demand, precautionary demand, and speculative
demand for money shown in the previous slide

Total Demand for Money and the Supply
of Money
13-30
20
18
16
14
12
10
8
6
4
2
T
otal demand
for money
M
7.2%

200

0
400
600
800
1,000
1,200
1,400
1,600
1,800
The interest rate of 7.2
percent is found at the
intersection of the total
demand for money and
the supply of money (M)
Since at any given time the
supply of money (M) is fixed
it can be represented as a
vertical line

0
Interest
Rate
(percent
per
year)
Quantity Of Money (billions of dollars)
Money Market Equilibrium
Money supply
9
g1
7
E1
Money
demand
g2
The amount of money
demanded (held)
depends on interest rates

Reserve Bank of India (RBI) & Monetary Policy:
By
MPSTME,
NMIMS Mumbai

Reserve Bank of India (RBI):
The RBI was established on April 1,
1935 as a shareholder’s bank with a
share capital of Rs. 5 crores, divided
into shares of Rs. 100 each fully paid
up. The entire share capital was, in
the beginning owned by the private
shareholders. The (then)Government
of India held shares of nominal value
of Rs. 2,22,000. It was nationalized on
January 1, 1949 and it then became a
State owned institution under the
Reserve Bank (Transfer to Public
Ownership) of India Act 1948. As the
central bank of the country, the RBI
is the apex institution in the Indian
monetary system.

Structure of Banking in India
Reserve Bank
Commercial Bank Co-operative Bank
-Public Sector Bank -State Co-op bank
-Private Sector bank -Central Co-op Bank
-Regional Rural Bank -Primary Co-op Soc

RBI as a CENTRAL BANK:
The Central Bank is the apex bank in the country. It is called by different names in
different countries. It is the Reserve Bank of India in India, the Bank of England in
England, the Federal Reserve System in America, the Bank of France in France, etc.
A central bank has been defined in terms of its functions.
According to Vera Smith, “ The primary definition of central banking is a banking
system in which a single bank has either complete control or a residuary monopoly
of note issue”.

FUNCTIONS OF RBI
REGULATOR OF CURRENCY
BANKER, FISCAL AGENT AND ADVISOR TO GOVERNMENT
CUSTODIAN OF CASH RESERVES FOR COMMERCIAL BANKS
CUSTODY AND MANAGEMENT OF FOREIGN EXCHANGE RESERVES
LENDER OF THE LAST RESORT
CLEARING HOUSE FOR TRANSFER AND SETTLEMENTS
CONTROLLER OF CREDIT
OTHER FUNCTIONS i.e. developing a strong banking system, supervision of
commercial banks, regulation of branch expansion, etc.

OBJECTIVES:
TO STABLISE THE INTERNAL PRICE LEVEL
TO STABLISE THE RATE OF FOREIGN EXCHANGE
TO PROTECT THE OUTFLOW OF GOLD
TO CONTROL BUSINESS CYCLE
TO MEET BUSINESS NEED
TO HAVE GROWTH WITH STABILITY etc.

Monetary Policy of India is formulated and executed by Reserve Bank of India (RBI) to
achieve specific objectives.
The monetary policy is defined as discretionary act undertaken by the authorities
designed to influence (A) the supply of money (B) cost of money or rate of interest (C)
the availability of money for achieving specific objectives
The main elements of monitory policy are
(1) It regulates stock and growth rate of money supply
(2) It regulates the entire banking system of the economy
(3) It regulates the level an structure of interest rates directly in organised sector and
indirectly in unorganised sector
(4) It determines the allocation of loans among different sectors

OBJECTIVES OF
MONETARY POLICY
Full employment
To attain price Stability
To Promote economic growth
To attain exchange stability
To Promote saving and investment
To Control Trade cycle
To Promote Employment
To Regulate Money Supply In Economy

INSTRUMENTS OF
MONETARY POLICY
Bank Rate
Statutory Liquidity Ratio
Open Market Operations
Cash Reserve Ratio
Repurchase Auction Rate(Repo) and Reverse Repurchase Auction Rate (Reverse Repo)
Margin Requirement
Credit Ceiling
Direct Action
Moral Persuasion

LIMITATIONS OF
MONETARY
POLICY MEASURES
Poor Banking Habit
Underdeveloped Money Market
Existence Of Black Money
Conflicting Objectives
Lack Of Coordination With Fiscal Policy
Lack Of Banking Facilities
Limitations of Monetary Instruments

Fiscal policy is related to income and expenditure of the government. It is an
instrument for promoting economic growth, employment,
social welfare etc. Fiscal policy means any decision to change the level,
composition or timing of government or to change the rate and structure of
tax. The objectives of fiscal policy is same as of monetary policy.

INSTRUMENTS OF
FISCAL POLICY
Public
Expenditure
Taxation Policy
Public Debt
Deficit
Financing

Public expenditure influences the economic activities of country very much.
Public expenditure may be of two kinds i.e. developmental and non
developmental. Expenditure on developmental activities requires huge
amount of capital. So much capital cannot be made available by private
sector alone. It requires substantial increase in public expenditure. Public
expenditure may be made in many ways (1) Development of state enterprises
(2) support to private sector (3) Development of infrastructure (4) Social
Welfare.

Taxes are the main source of revenue of government. Government
levies both direct and indirect taxes in India. The main objectives of
taxation policy are:
(1) Mobilisation of resources
(2) To promote saving
(3) To promote saving
(4) To bring Equality of income and wealth

• Government needs lot of funds for economic development of the country.
No government can mobilise so much funds by way of tax alone. It is
therefore , becomes inevitable for the government to mobilise resources for
economic development by resorting the public debt. Public debt is obtained
from two kinds
• (1) Internal Debt
• (2) External Debt

Deficit Financing refers to financing the budgetary deficit. Budgetary deficit here
means excess of government expenditure over government income. It means “Taking
loans from reserve bank of India by the government to meet the budgetary deficit” .

Limitations Of Fiscal
Policy
Limitations Of Fiscal
Policy
Lack of accurate Forecasting
Lack of accurate Forecasting
Delay in Decision
Delay in Decision
Poor Tax Administration
Poor Tax Administration
Inequality of income
Inequality of income
Failure in Public Sector
Failure in Public Sector
Increasing Interest Burden
Increasing Interest Burden

Utility and Cardinal Utility analysis
By
MPSTME, NMIMS Mumbai

Introduction to Utility Analysis
Meaning of Utility
 Utility means - The power of a commodity that satisfy the wants of
consumer - want satisfying power
 Introduced by Jermy Bentham
 Measurement ‘Utils’
 Subjective entity

Cardinal Utility analysis and Ordinal Utility Analysis

Cardinal Utility analysis and Ordinal Utility Analysis
Cardinal Utility analysis Ordinal Utility Analysis
Utility Analysis
• Alfred Marshal
• can be measured
• ‘Utils’
• Law of Diminishing Marginal
Utility
• Quantitative
. Subjective entity or Personal
•Law of Equi-marginal Utility
•Marshallian Analysis
• J. R. Hicks & R.G.D. Allen
•Cannot be measured but compared
as rank
• Indifference Curve analysis

Utility…..
• FORM
• PLACE
• TIME
etc….

Total Utility(TU) and Marginal Utility(MU)

Unit of
Mango
Total
Utility
Marginal
Utility
1 10
2 20
3 29
4 37
5 43
6 48
7 51
8 52
9 52
10 50
•Total Utility is the sum utility derived from
the consumption of bundle of commodity
•Marginal Utility is the rate of change of TU
from one more unit of extra consumption
MUn = TUn – TUn-1
MU =∆TU/∆Q

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
•Total Utility is the sum utility derived
from the consumption of bundle of
commodity
•Marginal Utility is the rate of change
of TU from one more unit of extra
consumption
MUn = TUn – TUn-1
MU =∆TU/∆Q

Cardinal Utility Analysis
a) Assumptions of Cardinal Utility analysis
b) Law of Diminishing Marginal Utility
c) Law of Equal-Marginal Utility

Assumptions of Cardinal Utility analysis
1. Rationality of consumer
2. Cardinal measurability of utility
3. Marginal Utility of Money is constant
4. Diminishing Marginal Utility
5. Utility is Additive – TU= Ux+ Uy+ Uz+…….+ Un
6. The hypothesis of Independent Utility
etc….

Law of Diminishing Marginal Utility
• Gossen first law
•According to Alfred Marshall ‘the additional utility which a person derive
from the consumption a commodity diminishes, that is Total Utility increase
at an diminishing rate ‘

‘the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate ‘
Unit of
Mango
Total
Utility
Marginal
Utility
1 10
2 20
3 29
4 37
5 43
6 48
7 51
8 52
9 52
10 50
MUn = TUn – TUn-1
MU =∆TU/∆Q

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2

Unit of
Mango
Total
Utility
Marginal
Utility
1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
TU
MU
No of mango
No of mango
TU
MU

TU
MU
Saturation Point MU =0 or TU is maximum
TU
MU
No of mango
No of mango

Application of Law of Diminishing Marginal Utility
1. Bases of law of demand- why demand curve slops downward
2. Law of equi- marginal utility is derived
3. Consumer surplus derived
4. Progressive Tax can be justified
etc….

Law of Equal-Marginal Utility
Consumer’s Equilibrium under Marshellian analysis
(Goosen’s Second Law)

Law of Equal-Marginal Utility
Consumer’s Equilibrium under Marshellian analysis
•Gossen Second Law
•Explain how consumer is maximize his satisfaction by allocating his income with
different commodity at various prices.
• Condition for consumer equilibrium two commodity
MUx/Px = MUy/Py = ……………………. MUn/P n = MU m
MUx/Px = MUy/Py = MU m
• Condition for consumer equilibrium more commodity

Consumer Surplus
• Consumer Surplus - the difference between the price
buyers pay for a good and the maximum amount
they would have paid for the good.
• Example:
• I’m willing to pay $6 for a case of soda
• Soda is on sale for $5 a case
• Consumer surplus = $1

Critical evaluation of Cardinal Utility analysis
• Utility is not Cardinally measurable
• Marginal Utility of money is not constant
• Utilities are interdependent.
• Failure to explain Giffen Paradox
• Failure to distinguish income effect and
substitution effect
etc….

21
Ordinal utility
• Ordinal utility holds that utility cannot
be measured but can be ordered
according to consumers’ preferences.
• Different product combinations may be
viewed as having same utility,
• And these combinations of same utility
consist of one Indifference Curve (IC).

22
Indifference Curve
Indifference Curve (IC) contains points representing
market baskets among which the consumer is
indifferent.
)
,
( 2
1 X
X
f
U 

23
• indifference curve
A locus of points representing different
bundles of goods and services, each of which
yields the same level of total utility.

24
X1
X2
O
I2
I3
I1
Indifference curve（IC）
Increasing
satisfaction

25
The important things of IC
1. IC is convex to the origin.
2.Every indifference curve must (?)
slope downward and to the right;
3. Indifference curves cannot intersect.

26
Another important but not mentioned
thing about IC:
A consumer has many indifference
curves;
How do you understand this attribute?

27
U = f（X1，X2）= U1
U = f（X1，X2）= U1
X1
X2
ΔX1=1
ΔX2
O
IC
ΔX1=1
A
B
C
ΔX2 /ΔX1

28
Marginal Rate of Substitution (MRS)
MRS is defined as the number of
units of good Y that must be given up if
consumer is to receive an extra unit of
good X and to maintain a constant level
of satisfaction.

29
To calculate MRS
To calculate MRS
1
2
12
X
X
MRS





30
• Not all indifference curves must
slope downward.
• Can you name some other cases?
• What will the IC of substitutes
& complements?

31
IC of substitutes
IC of substitutes
X1
X2
I2
I1
O

32
X1
X2
I2
I1
IC of compliments
IC of compliments

33
The budget line
• Consumers want to be most
satisfactory, but to be constrained by
their income (budget).
• Budget refers to various possible
combinations of products that
consumers can buy when their income
& products’ prices are set.

34
X1
X2
I / P2
I / P1
Budget Space
The budget line

35
Variation of budget line
Discuss
• P1& P2 hold constant while I changes;
• I holds constant while P1&P2 change
proportionately;
• I holds constant while P1 or P2
changes;
• I, P1&P2 increase or decrease
proportionately at the same time.

36
1
2
1
2
2 X
P
P
P
I
X 

X1
X2
I / P2
I / P1
I decrease I increase
“I” changes

37
1
2
1
2
2 X
P
P
P
I
X 

X1
X2
I / P2
I / P1
P1 increases P1 decreases
P1 changes

38
Question
What if P2 changes ?
And I, P1 & P2 change?

39
The Equilibrium of Market Basket
• Consumers want to be most
satisfactory;
• But they are constrained by their
income (budget).
• Consumers (rational) want to
maximize their utility with limited
income.

40
Budget line & Indifference curve
I1
I2
I3
E
Discuss:
How do you
understand E?
Discuss:
How do you
understand E?
B
C
X1
X2
O

41
If only prices change
If only prices change
PCC
PCC
Price-Consumption
curve
Price-Consumption
curve
Price changes
→ PCC
Price changes
→ PCC
X
Y
O
I2
I3
I1
E2
E3
E1
XE1 XE2 XE3

42
X
Y
O
I2
I3
I1
E2
E3
E1
XE1 XE2
XE3
A1
A2
A3
ICC
If only income changes
If only income changes
Income changes
→ ICC
Income changes
→ ICC

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