Money and Banking — NCERT Solutions

A barter system is a system of exchange in which goods and services are exchanged directly for other goods and services, without the use of money.

Its drawbacks are:

• It requires double coincidence of wants: each person must want exactly what the other offers.
• It is difficult to find suitable exchange partners, so search costs are high.
• It is hard to store wealth in perishable goods like rice.
• Many goods are difficult to divide, transport, or keep safely.
• It becomes inconvenient as the number of people and transactions increases.

So, barter is inefficient in a large economy and money is needed to make exchanges easier.

The main functions of money are:

1. Medium of exchange
2. Unit of account
3. Store of value

Money overcomes the shortcomings of barter in these ways:

• As a medium of exchange, it removes the need for double coincidence of wants. People can sell goods for money and then buy what they need.
• As a unit of account, it allows the value of all goods and services to be expressed in one common measure, making comparison and calculation easy.
• As a store of value, it helps people carry wealth forward to the future because money is not perishable and has low storage cost, unlike many barter goods.

Thus, money makes exchange easier, wealth easier to store, and economic transactions simpler.

Transaction demand for money is the amount of money people want to hold in order to carry out their day-to-day transactions.

It is related to the value of transactions over a period of time because the larger the value of transactions, the more money people need to keep for spending. In the chapter, it is shown that transaction demand is positively related to the value of nominal transactions:

$$M_T^d = kT$$

where $T$ is the total value of transactions over a unit period and $k$ is a positive fraction.

Since the value of transactions is generally related to income and price level, transaction demand for money rises when income or price level rises.

The alternative definitions of money supply in India are:

• M1 = CU + DD
• M2 = M1 + savings deposits with Post Office savings banks
• M3 = M1 + net time deposits of commercial banks
• M4 = M3 + total deposits with Post Office savings organisations (excluding National Savings Certificates)

Here, CU means currency held by the public and DD means net demand deposits held by commercial banks.

So the four measures are M1, M2, M3 and M4.

A legal tender is money that cannot be refused by any citizen for settlement of a transaction. In the chapter, currency notes and coins are described as legal tenders.

Fiat money is money whose value comes from the guarantee of the issuing authority, not from the intrinsic value of the material it is made of. Currency notes and coins are fiat money because their paper or metal value is much less than their face value, but they are accepted because the government and RBI guarantee them.

So, legal tender refers to money that must be accepted, and fiat money refers to money that has value because of official backing, not intrinsic worth.

High-powered money is the currency issued by the central bank that can be held by the public or by commercial banks. The chapter also calls it reserve money or the monetary base because it forms the basis for credit creation by banks.