Part-A Multiple Choice Questions
| 1. The RBI Headquarters is located at | ||
| (a) Delhi | ||
| (b) Chennai | ||
| (c) Mumbai | a | |
| (d) Bengaluru | ||
| 2. Money is | ||
| (a) acceptable only when it has intrinsic value | ||
| (b) constant in purchasing power | ||
| (c) the most liquid of all assets | a | |
| (d) needed for allocation of resources | ||
| 3. Paper currency system is managed by the | ||
| (a) Central Monetary authority | a | |
| (b) State Government | ||
| (c) Central Government | ||
| (d) Banks | ||
| 4. The basic distinction between M1 and M2 is with regard to | ||
| (a) post office total deposits | ||
| (b) saving deposits with post office savings bank | a | |
| (c) Terms deposits of banks | ||
| (d) currency | ||
| 5. Irving Fisher’s Quantity Theory of Money was popularized in | ||
| (a) 1908 | ||
| (b) 1910 | ||
| (c) 1911 | a | |
| (d) 1914 | ||
| 6. MV stands for | ||
| (a) demand for money | ||
| (b) supply of legal tender money | a | |
| (c) Supply of bank money | ||
| (d) Total supply of money | ||
| 7. Inflation means | ||
| (a) Prices are rising | a | |
| (b) Prices are falling | ||
| (c) Value of money is increasing | ||
| (d) Prices are remaining the same | ||
| 8. _________ inflation results in a serious depreciation of the value of money. | ||
| (a) Creeping | ||
| (b) Walking | ||
| (c) running | ||
| (d) Hyper | a | |
| 9. _________ inflation occurs when general prices of commodities increases due to increase in production costs such as wages and raw materials. | ||
| (a) Cost-push | a | |
| (b) demand pull | ||
| (c) running | ||
| (d) galloping | ||
| 10. During inflation, who are the gainers? | ||
| (a) Debtors | a | |
| (b) Creditors | ||
| (c) Wage and salary earners | ||
| (d) Government | ||
| 11. ___________ is a decrease in the rate of inflation. | ||
| (a) Disinflation | a | |
| (b) Deflation | ||
| (c) Stagflation | ||
| (d) Depression | ||
| 12. Stagflation combines the rate of inflation with | ||
| (a) Stagnation | a | |
| (b) employment | ||
| (c) output | ||
| (d) price | ||
| 13. The study of alternating fluctuations in business activity is referred to in Economics as | ||
| (a) Boom | ||
| (b) Recession | ||
| (c) Recovery | ||
| (d) Trade cycle | a | |
| 14. During depression the level of economic activity becomes extremely | ||
| (a) high | ||
| (b) bad | ||
| (c) low | a | |
| (d) good | ||
| 15. “Money can be anything that is generally acceptable as a means of exchange and that the same time acts as a measure and a store of value”, This definition was given by | ||
| (a) Crowther | a | |
| (b) A.C.Pigou | ||
| (c) F.A.Walker | ||
| (d) Francis Bacon | ||
| 16. Debit card is an example of | ||
| (a) currency | ||
| (b) paper currency | ||
| (c) plastic money | a | |
| (d) money | ||
| 17. Fisher’s Quantity Theory of money is based on the essential function of money as | ||
| (a) measure of value | ||
| (b) store of value | ||
| (c) medium of exchange | a | |
| (d) standard of deferred payment | ||
| 18. V in MV = PT equation stands for | ||
| (a) Volume of trade | ||
| (b) Velocity of circulation of money | a | |
| (c) Volume of transaction | ||
| (d) Volume of bank and credit money | ||
| 19. When prices rise slowly, we call it | ||
| (a) galloping inflation | ||
| (b) mild inflation | a | |
| (c) hyper inflation | ||
| (d) deflation | ||
| 20. __________ inflation is in no way dangerous to the economy. | ||
| (a) walking | ||
| (b) running | ||
| (c) creeping | a | |
| (d) galloping | ||
Part – B Answer the following questions in one or two sentences
21. Define Money.
Answer: According to Crowther “Money can be anything that is generally acceptable as a means of exchange and at the same time acts as a measure and a store of value”.
22. What is barter?
Answer: Before money was invented, exchange took place by Barter, that is, commodities
and services were directly exchanged for other commodities and services. Surplus goods were exchanged for money which in turn was exchanged for other needed goods. Goods like furs, skins, salt, rice, wheat, utensils, weapons, etc. were commonly used as money. Such exchange of goods for goods was known as “Barter Exchange” or “Barter System”.
23. What is commodity money?
Answer: Commodity money is a type of money that has intrinsic value, meaning that its value is derived from the value of the commodity that it is made from. Examples of commodity money include gold coins, silver coins, and copper coins.
24. What is gold standard?
Answer: Gold Standard is a system in which the value of the monetary unit or the standard currency is directly linked with gold. The monetary unit is defined in terms of a certain weight of gold.
25. What is plastic money? Give example.
Answer: Plastic money is an alternative to the cash or the standard money. Plastic money is a term that is used in reference to the hard plastic cards used every day in place of actual bank notes. Plastic money can come in many different forms such as Cash cards, Credit cards, Debit cards, Pre-paid Cash cards, Store cards, Forex cards and Smart cards. They aim at removing the need for carrying cash to make transactions.
26. Define inflation.
Answer: Inflation is a consistent and appreciable rise in the general price level. It is the rate at which the general level of prices for goods and services is rising and consequently the purchasing power of currency is falling.
27. What is Stagflation?
Answer: Stagflation is a combination of stagnant economic growth, high unemployment and high inflation. It is the co-existence of a high rate of unemployment and inflation derived from stagnation and inflation.
Part – C Answer the following questions in one paragraph
28. Write a note on metallic money.
Answer: Under metallic standard, some kind of metal either gold or silver is used to determine the standard value of the money and currency. Standard coins made out of the metal are the principal coins used under the metallic standard. These standard coins are full bodied or full weighted legal tender. Their face value is equal to their intrinsic metal value.
29. What is money supply?
Answer: Money supply means the total amount of money in an economy. It refers to the amount of money which is in circulation in an economy at any given time. Money supply plays a crucial role in the determination of price level and interest rates. Money supply viewed at a given point of time is a stock and over a period of time it is a flow.
30. What are the determinants of money supply?
Answer: The determinants of money supply are:
- Currency Deposit Ratio (CDR): It is the ratio of money held by the public in currency to that they hold in bank deposits.
- Reserve deposit Ratio (RDR): Reserve Money consists of two things (a) vault cash in banks and (b) deposits of commercial banks with RBI.
- Cash Reserve Ratio (CRR): It is the fraction of the deposits the banks must keep with RBI.
- Statutory Liquidity Ratio (SLR): It is the fraction of the total demand and time deposits of the commercial banks in the form of specified liquid assets.
31. Write the types of inflation.
Answer: The types of inflation are:
On the basis of speed:
- i) Creeping Inflation:
- ii) Walking Inflation:
- iii) Running Inflation:
- iv) Galloping inflation
On the basis of demand and cost
- i) Demand-Pull Inflation
- ii) Cost-Push Inflation
On the basis of inducement:
- i) Currency inflation:
- ii) Credit inflation:
- iii) Deficit induced inflation
- iv) Profit induced inflation
- v) Scarcity induced inflation
- vi) Tax induced inflation
32. Explain Demand-pull and Cost push inflation.
Answer:
Demand-Pull Inflation: Demand and supply play a crucial role in deciding the inflation levels in the society at all points of time. For instance, if the demand is high for a product and supply is low, the price of the products increases.
Cost-Push Inflation: When the cost of raw materials and other inputs rises inflation results. Increase in wages paid to labour also leads to inflation.
33. State Cambridge equations of value of money.
Answer: There are two Cambridge equations of value of money.
Marshall’s Equation
The Marshall equation is expressed as: M = KPY where M is the quantity of money; Y is the aggregate real income of the community; P is Purchasing Power of money; K represents the fraction of the real income which the public desires to hold in the form of money.
Thus, the price level P = M/KY or the value of money (The reciprocal of price level) is 1/P = KY/M. The value of money can be found out by dividing the total quantity of goods which the public desires to holdout of the total income by the total supply of money.
Keynes’ Equation : Keynes equation is expressed as:
n = pk (or) p = n / k where n is the total supply of money; p is the general price level of consumption goods; k is the total quantity of consumption units the people decide to keep in the form of cash.
According to Keynes, peoples’ desire to hold money is unaltered by monetary authority. So, price level and value of money can be stabilized through regulating quantity of money (n) by the monetary authority.
Later, Keynes extended his equation in the following form:
- n = p (k + rk’) or p = n/(k + rk’) where,
- n = total money supply
- p = price level of consumer goods
- k = peoples’ desire to hold money in hand
- r = cash reserve ratio
- k’ = community’s total money deposit in banks, in terms of consumer goods.
In this extended equation also, Keynes assumes that, k, k’ and r are constant. In this situation, price level (P) is changed directly and proportionately changing in money volume (n).
34. Explain disinflation.
Answer: Disinflation is the slowing down the rate of inflation by controlling the amount of credit (bank loan, hire purchase) available to consumers without causing more unemployment. Disinflation may be defined as the process of reversing inflation without creating unemployment or reducing output in the economy.
Part – D Answer the following questions in about a page
35. Illustrate Fisher’s Quantity theory of money.
Answer: American economist, Irving Fisher gave the Quantity Theory of Money a quantitative form in terms of his famous “Equation of Exchange”.
The general form of equation given by Fisher is MV = PT; where
- M = Money Supply/quantity of Money
- V = Velocity of Money
- P = Price level
- T = Volume of Transaction.
Fisher points out that during any given period of time, the total quantity of money (MV) will be equal to the total value of all goods and services bought and sold (PT).
MV = PT
Supply of Money = Demand for Money
This equation is referred to as “Cash Transaction Equation”.
It is expressed as P = MV / T which implies that the quantity of money determines the price level and the price level in its turn varies directly with the quantity of money, provided ‘V’ and ‘T’ remain constant.
The above equation considers only currency money. But, in a modern economy, bank’s demand deposits or credit money and its velocity play a vital part in business. Therefore, Fisher extended his original equation of exchange to include bank deposits M1 and its velocity V1. The revised equation was:
PT = MV + M1V1
P = MV + M1V1/ T
From the revised equation, it is evident, that the price level is determined by
- (a) the quantity of money in circulation ‘M’
- (b) the velocity of circulation of money ‘V’
- (c) the volume of bank credit money M1
- (d) the velocity of circulation of credit money V1 and the volume of trade (T)
Figure (A) shows the effect of changes in the quantity of money on the price level. When the quantity of money is OM, the price level is OP. When the quantity of money is doubled to OM2, the price level is also doubled to OP2 . When the quantity of money is increased four-fold to OM4 , the price level also increases by four times to OP4 . This relationship is expressed by the curve OP = f (M) from the origin at 450.
Figure (B), shows the inverse relation between the quantity of money and the value of money, where the value of money is taken on the vertical axis. When the quantity of money is OM, the value of money is OI / P. But with the doubling of the quantity of money to OM2 , the value of money becomes one-half of what it was before, (OI / P2). But, with the quantity of money increasing by four-fold to OM4, the value of money is reduced by OI / P4. This inverse relationship between the quantity of money and the value of money is shown by downward sloping curve IO / P = f(M).
36. Explain the functions of money.
Answer: The main functions of money can be classified into four categories.
1.Primary Functions:
i) Money as a medium of exchange: Money has the quality of general acceptability, and all exchanges take place in terms of money. First, money is obtained through sale of goods or services. This is known as sale. Later, money is obtained to buy goods and services. This is known as purchase. Thus, in the modern exchange system money acts as the intermediary in sales and purchases.
ii) Money as a measure of value: Money measures the value of goods and services. The prices of all goods and services are expressed in terms of money. Money is thus a collective measure of value. Since all the values are expressed in terms of money, it is easier to determine the rate of exchange between various types of goods in the community.
2.Secondary Functions
i) Money as a Store of value: With the invention of money, savings are now done in terms of money. Money also serves as an excellent store of wealth, as it can be easily converted into other marketable assets, such as, land, machinery, plant etc.
ii) Money as a Standard of Deferred Payments: Modern money-economy has greatly facilitated the borrowing and lending processes. Money now acts as the standard of deferred payments.
iii) Money as a Means of Transferring Purchasing Power: The field of exchange also went on extending with growing economic development. The exchange of goods is now extended to distant lands. It is therefore necessary to transfer purchasing power from one place to another.
3.Contingent Functions
i) Basis of the Credit System: Money is the basis of the Credit System. Business transactions are either in cash or on credit. For example, a depositor can make use of cheques only when there are sufficient funds in his account. The commercial banks create credit on the basis of adequate cash reserves. But, money is at the back of all credit.
ii) Money facilitates distribution of National Income: The invention of money has now facilitated the distribution of income as rent, wage, interest and profit.
iii) Money helps to Equalize Marginal Utilities and Marginal Productivities: Consumer can obtain maximum utility only if he incurs expenditure on various commodities in such a manner as to equalize marginal utilities accruing from them. In equalizing these marginal utilities, money plays an important role, because the prices of all commodities are expressed in money. Money also helps to equalize marginal productivities of various factors of production.
iv) Money Increases Productivity of Capital: Money is the most liquid form of capital. Capital in the form of money can be put to any use. It is on account of this liquidity of money that capital can be transferred from the less productive to the more productive uses.
4.Other Functions
i) Money helps to maintain Repayment Capacity: Money possesses the quality of general acceptability. To maintain its repayment capacity, every firm has to keep assets in the form of liquid cash. Likewise, banks, insurance companies and even governments have to keep some liquid money to maintain their repayment capacity.
ii) Money represents Generalized Purchasing Power: Purchasing power kept in terms of money can be put to any use. It is not necessary that money should be used only for the purpose for which it has been served.
iii) Money gives Liquidity to Capital: Money is the most liquid form of capital. It can be put to any use.
37. What are the causes and effects of inflation on the economy?
Answer: Inflation is a consistent and appreciable rise in the general price level. The main causes of inflation in India are as follows:
i) Increase in Money Supply: Inflation is caused by an increase in the supply of money which leads to increase in aggregate demand. The higher the growth rate of the nominal money supply, the higher is the rate of inflation.
ii) Increase in Disposable Income: When the disposable income of the people increases, it raises their demand for goods and services. Disposable income may increase with the rise in national income or reduction in taxes or reduction in the saving of the people.
iii) Increase in Public Expenditure: Government activities have been expanding due to developmental activities and social welfare programmes. This is also a cause for price rise.
iv) Increase in Consumer Spending: The demand for goods and services increases when they are given credit to buy goods on hire-purchase and installment basis.
v) Cheap Money Policy: Cheap money policy leads to increase in the money supply which raises the demand for goods and services in the economy.
vi) Deficit Financing: In order to meet its mounting expenses, the government resorts to deficit financing by borrowing from the public and even by printing more notes. This raises aggregate demand in relation to aggregate supply, thereby leading to inflationary rise in prices.
vii) Black Assets, Activities and Money: The existence of black money and black assets due to corruption, tax evasion etc., increase the aggregate demand. People spend such money, lavishly. Black marketing and hoarding reduces the supply of goods. These trends tend to raise the price level further.
viii) Repayment of Public Debt: Whenever the government repays its past internal debt to the public, it leads to increase in the money supply with the public. This tends to raise the aggregate demand for goods and services.
ix) Increase in Exports: When exports are encouraged, domestic supply of goods decline. So prices rise.
Effects of Inflation
The effects of inflation can be classified into two heads:
(1) Effects on Production and (2) Effects on Distribution.
1. Effects on Production:
When inflation is very moderate, it acts as an incentive to traders and producers. This is particularly prior to full employment when resources are not fully utilized. The profit due to rising prices encourages and induces business class to increase their investments in production, leading to generation of employment and income.
i) Hyper-inflation results in a serious depreciation of the value of money and it discourages savings on the part of the public.
ii) When the value of money undergoes considerable depreciation, this may even drain out the foreign capital already invested in the country.
iii) With reduced capital accumulation, investment will suffer a serious set-back which may have an adverse effect on the volume of production in the country. This may discourage entrepreneurs and businessmen from taking business risk.
iv) Inflation leads to hoarding of essential goods both by the traders as well as the consumers, leading to still higher inflation rate.
v) Inflation encourages investment in speculative activities rather than productive purposes.
2. Effects on Distribution
i) Debtors and Creditors: During inflation, debtors are the gainers while the creditors are losers. The reason is that the debtors had borrowed when the purchasing power of money was high and now repay the loans when the purchasing power of money is low due to rising prices.
ii) Fixed-income Groups: The fixed income groups are the worst hit during inflation because their incomes being fixed do not bear any relationship with the rising cost of living. Examples are wage, salary, pension, interest, rent etc.
iii) Entrepreneurs: Inflation is a boon to entrepreneurs such as manufacturers, traders, merchants or businessmen. They experience windfall gains as the prices of their inventories suddenly go up.
iv. Investors: The investors, who generally invest in fixed interest yielding bonds and securities have much to lose during inflation. Those who invest in shares stand to gain by rich dividends and appreciation in value of shares.
38. Describe the phases of Trade cycle.
The economic activity in a capitalist economy will have its periodic ups and downs. The study of these ups and downs is called the study of Business cycle or Trade cycle or Industrial Fluctuation.
A Trade cycle refers to oscillations in aggregate economic activity particularly in employment, output, income, etc. It is due to the inherent contraction and expansion of the elements which energize the economic activities of the nation. The fluctuations are periodical, differing in intensity and changing in its coverage.
The four different phases of trade cycle is referred to as (i) Boom (ii) Recession (iii) Depression and (iv) Recovery.
i) Boom or Prosperity Phase: Full employment and the movement of the economy beyond full employment is characterized as boom period. During this period, there is hectic activity in economy. Money wages rise, profits increase and interest rates go up. The demand for bank credit increases and there is all-round optimism.
ii) Recession: The turning point from boom condition is called recession. Generally, the failure of a company or bank bursts the boom and brings a phase of recession. Investments are drastically reduced, production comes down and income and profits decline. There is panic in the stock market and business activities show signs of dullness. Liquidity preference of the people rises and money market becomes tight.
iii) Depression: During depression the level of economic activity becomes extremely low. Firms incur losses and closure of business becomes a common feature and the ultimate result is unemployment. Interest prices, profits and wages are low. The agricultural class and wage earners would be worst hit. Banking institutions will be reluctant to advance loans to businessmen. Depression is the worst phase of the business cycle. Extreme point of depression is called as “trough”, because it is a deep point in business cycle.
Keynes advocated that autonomous investment of the government alone can help the economy to come out from the depression.
iv. Recovery: After a period of depression, recovery sets in. This is the turning point from depression to revival towards upswing. It begins with the revival of demand for capital goods.
Autonomous investments boost activity. The demand slowly picks up and in due course the activity is directed towards the upswing with more production, profit, income, wages and employment. Recovery may be initiated by innovation or investment or by government expenditure (autonomous investment).
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