CBSE XII Macroeconomics - Money

2. Money
Grade XII
Economics

3. Learning Objectives
• To understand barter system analyse its disadvantages
• To know the definition of money
• To understand the functions of money
• To understand about time deposits and demand deposits
• To know about fiat money
• To analyse the four measures of money supply given by
the RBI
• To identify high powered money

4. Barter Exchange
It implies the direct exchange of goods for goods
without the use of money.

5. Barter Exchange
1. Double coincidence of wants:
•Barter system can only work, when both the
persons are ready to exchange each other’s
goods i.e. person A should have the good
person B wanted and vice-versa.
•But Usually this type of double coincidence is
rare, especially in modern times.

6. Barter Exchange
2. Absence of Common Measure of Value:
• Even if it is possible to have the double coincidence of
wants, the absence of a common measure of value creates
great problem because a lot of time is wasted to strike a
bargain.
• Since there is no common measure in terms of which the
value of a commodity can be expressed, the problem arises
how much wheat should be exchanged for how many pairs
of shoe.

8. Barter Exchange
3. Lack of Divisibility:
• All goods cannot be divided and subdivided. In the absence
of a common medium of exchange, a problem arises, when
a big indivisible commodity is to be exchanged for a smaller
commodity.
• For example, if the price of a horse is equal to 10 shirts,
then a person having one shirt cannot exchange it for the
horse because it is not possible to divide the horse in small
pieces without destroying its utility.

9. Barter Exchange
4. The Problem of Storing Wealth:
• Individuals have to store specific purchasing power (in the
form of horses, shoes, wheat etc.) under the barter system
which may decrease in value in the due course of time due
to physical deterioration or a change in tastes,
• It is very expensive to store specific goods for a long time.
• The wealth stored in the form of specific goods may create
jealousy and enmity among the neighbors or relatives.

10. Barter Exchange
5. Difficulty of Deferred Payments:
• The barter system does not provide a satisfactory unit in terms of which
the contracts about the deferred (future) payments are to be written.
• Under barter system, future payments are written in terms of specific
goods. It creates many problems.
• It may create controversy regarding the quality of goods or services to be
repaid in future.
• The two parties may be unable to agree on the specific good to be used
for repayment.
• Both parties run the risk that the goods to be repaid may increase or
decrease in value over the period of contract.

11. Barter Exchange
6. Problem of Transportation:
• Goods and services cannot be transported conveniently
from one place to another.
• For example, it is not easy and without risk for an individual
to take heaps of wheat or herd of cattle to a distant market
to exchange them for other goods.
• With the use of money, the inconveniences or risks of
transportation are removed.

12. Money
Money may be defined as anything which is generally
acceptable and legally valid as a medium of exchange and at
the same time acts as a measure of value, store of value and
a standard of deferred payments.

13. Functions of Money
(i) Primary Functions of Money
(a) Medium of exchange
(b) Common unit of account or unit of account
(ii) Secondary Functions of Money
(a) Store of value
(b) Transfer of value
(c) Standard of deferred payments

14. Medium of Exchange
• It acts as a medium of exchange between two parties
involved in a transaction.
• It avoids the practical problems of wastage of time and
resources, involved in the barter system of an exchange and
it improves the transactional efficiency.
• It also promotes allocational efficiency in the trade and
production of goods and services.
• Hence, it can be said that money has separated the acts of
sales and purchases.

15. Unit of Account Function of Money
• Money serves as a unit of value or common measure of value in
terms of which the value of all goods and services are
measured.
• This helps in measuring the exchange values of commodities.
• The prices of all the goods and services can be fixed in terms of
money and the problem of expressing of the value of each
commodity in terms of quantities of other goods can be
avoided.
• This function of money makes it possible to keep business
accounts.

16. Store of Value Function of Money
(i) The money is an asset that retains value over time provided price
remains constant. The public stores their wealth in the form of
money.
(ii) People can hold wealth in the form of money as it has general
acceptability.
(iii) It promotes capital formation by the way of new investment.

17. Standard of Deferred Payment Function of
Money
• Deferred payments means future payment.
• When we take a loan from somebody, we not only pay the
principal amount but also the interest amount.
• Under barter system of exchange, it was very difficult to
make such transactions.
• As money maintains a standard value over a period of time
provided price remains constant deferred payments can be
easily done.

18. Means of Transferring Value
• In the barter economy it was not possible to transfer values
of things like a house, tree, garden, etc., from one place to
another.
• But nowadays one can sell his movable immovable
property at one place and can buy such property
elsewhere.
• For this kind of transaction one can use money; money can
be easily transferred from one place to another through
cheques, bank drafts, money orders and other credit in-
struments.

19. Contingent
•The adjective contingent can be
used to describe something that
can occur only when something
else happens first.

20. Contingent Functions
a. Distribution of national income:
Money measures the contribution or productivity of each factor of
production and, thus, facilitates the distribution of national income among
the owners of resources
b. Basis of credit:
The credit-structure of an economy depends totally upon the parent base
of money. If the supply of money decreases, the credit system contracts.
c. Liquid form of all capital:
Money helps in bringing about a price system with the help of which all
kinds of capital goods can be changed into money.

21. Alternative Definitions of Money Supply in India
• Measures of M1 = C + DD + OD
• Currency notes and coins with the public [C]
• Demand deposits of all commercial and co-operative banks
excluding inter-bank deposits. (DD),
Other deposits with RBI [O.D]
Where, Other deposits are the deposits held by the RBI of all
economic units except the government and banks. OD includes
demand deposits of semi-government public financial institutions
(like IDBI, IFCI, etc.), foreign central banks and governments, the
International Monetary Fund, the World Bank, etc.

22. Measures of Money Supply
• Measures of M1 = C + DD + OD
• Measures of M2: M1[C + DD + OD] +Post office saving deposits
• Measures of M3: M1 + Time deposits of all commercial and co-
operative banks.
• Measures of M4: M3 +Total deposits with the post office saving
organization (excluding national savings certificates).

23. Narrow Money and Broad Money
•Narrow money refers to: M1 + M2
•Broad money refers to: M3 (d) M4

24. Types of Deposits
•Demand deposits are those deposits which can
be withdrawn by the depositor at any time by
means of cheque. No interest is paid on such
deposits.
•Time deposits are the deposits that cannot be
withdrawn before the expiry of the stipulated
time for which deposits are made. Fixed
deposit is an example of time deposit.

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

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

27. High Powered Money
• It is money produced by the RBI and the government.
• It consists of two things: currency held by the public and cash
reserves with the banks.

28. Review
•What is barter system? What are its disadvantages?
•Define money.
•Explain the functions of money.
•What are time deposits and demand deposits?
•Define fiat money.
•What are the four measures of money supply given
by the RBI?
•What is high powered money?

29. Lets Recap
• Barter system is the system m in which goods are exchanged for goods. Its
disadvantages are lack of double coincidence of wants, inability to store goods
for a long time, difficulty to assess the value of one good in terms of other good
and difficulty to carry goods easily.
• Money is any commonly accepted medium of exchange which is legally valid.
• Money has primary and secondary functions.
• Demand deposits can be withdrawn at any time. Fixed deposits area called time
deposits.
• Fiat money is currency notes and coins issued by the government. They don’t
have intrinsic value.
• M1, M2. M3 and M4 are the four measures of money supply given by the RBI.
• High powered money refers to currency and deposits held by the government
of India and commercial banks with RBI.