Economics Chapter 3 Money Class 12 Notes exercise, short question, and long question for the board of kpk. 2nd years notes economics in English medium. money and banking class 12 questions and answers.
Economics Chapter 3 Money Class 12 Notes
Table of Contents
Q.1) Define Money. What functions are performed by money?
“Money is anything that is widely used in payments of debts”.
OR
“Anything which is widely accepted in payment for goods or in the discharge of other obligations.”
Money is what money does. So to fully understand the nature of money, we have to consider the functions it performs. The important functions of money are the following.
1. Medium of exchange
This is the first and the primary function of money. Originally money was invented to act as a medium of exchange. In the barter economy people had to face many difficulties. With the use of money these difficulties and inconveniences are removed. Now there is no need for double coincidence of wants as it was required in barter economy. Money represents general purchasing power. For example, a person having cloth can sell it for money and then use the same amount to purchase any good he likes.
(Similarly other problems such as indivisibility of some goods or difficulties of storing goods have also been solved. This function of money was so important that economists, till the recent past, gave very little attention to other functions.)
2. Measure of value and unit of account
Money serves as a standard measure of value. Monetary unit (e.g. rupee in Pakistan) is used as a yardstick for measuring the relative values of goods. In barter there is zero standard unit of account in which value of all goods could be shown or added. In the money economy, since all values are expressed in terms of money units. It becomes possible to show the wealth of a person or national income of a country as one figure.
3. Store of value
In the barter economy, a very important problem was: in what form one should store wealth. Most people want to put away a part of their current incomes for use in future. But in the absence of money how they can do so. On the one hand, storing physical goods was costly and inconvenient and on the other, the stored goods could not readily be used to buy other commodities. Storing of services was impossible. Money has solved this problem too. Money is the most liquid of all assets and is a very convenient form in which wealth can be stored, this stored money can be used for any purchases at any time, as one likes. Moreover, no cause, no cost is involved in storing money.
4. Standard of deferred payments
Money is also used to make payments at some future time. Borrowing and lending take place in terms of money, which makes it possible to compare the values of commodities at different times. However, money can perform this function properly only if the value of money itself remains stable.
( it is this function of money, which has allowed so much expansion of economic activity. Modern economies heavily depend upon borrowed money or credit.
5. Means of Transferring Value
The transfer of value from one place to another is quite convenient with the help of money. A person may sell his movable or immovable property at some place for money and use the same to buy property at some other place. In this way money increases the geographical mobility of people.
6. Medium of Government Payments
The govt. receives taxes or duties such as fees in money form and pays salaries, pensions in terms of money.
7. Dynamic Functions
Dynamic functions of money have become very important in modern economies. These relate to the influence of money on level of prices, consumption and production of goods. Job opportunities and distribution of wealth, For example:
i) Change in money supply in the country causes changes in price levels. This in turn deeply influences economic activity.
ii) Change in money supply affects the rate of interest. If there is unemployment in the country and the business conditions are not good ,the government increases the supply of money, which lowers the rate of interest and encourages investment.
iii) Nowadays, deficit financing (i.e. printing of new money) is commonly used to get funds for financing development projects in the country.
iv) Due to use of money, exchange of goods becomes easier. Trade is facilitated and production of goods increases. Mobility of men and materials is facilitated.
v) Use of money increases, specialization of labour which increases productivity of labour.
Q.2) Explain the following concepts and give examples.
- a) Metallic Money
- b) Legal Tender
- c) Paper Money
- d) Credit Money
- e) Token Money
- f) Standard Money
Answer:
a) Metallic Money:
Metallic Money consists of coins such as Five.rupee coins in Pakistan. Importance of metallic money has decreased because of paper money.
b) Legal Tender
The money, which a person must legally accept for payment of dues, is called legal tender. In Pakistan all coins and currency notes are legal tender. Nobody can refuse to receive payment in legal money. A credit and currency note is not legal tender e.g. a person may accept a cheque or he may refuse it.
c) Paper Money
Paper money are currency notes issued by the Central Bank. In Pakistan, all currency notes are issued by the State Bank. Paper money came into use about two hundred years ago and rapidly replaced metallic money. Its importance is clear from the fact that more than 90% of total currency in circulation in Pakistan consists of paper money. All paper currency is Fiat Money. Because it was accepted as money due to government order.
i) Convertible: the government promises to change this currency into gold. If demanded.
ii) Nonconvertible: Against such money, the government has no promise to give gold, if demanded.
d) Credit Money
This is the most modern form of money. All deposits which can be drawn by Cheques are called money. Cheques in itself is not money. It is the deposit used through Cheques which is money. It is also called Deposit money. In developed countries most of the business is done through direct online transfer of funds. In Pakistan its use is increasing and in near future most transactions will be done through deposit money using credit cards/debit cards instead of currency.
e) Token Money
Nowadays all coins are token money. When the face value of a coin is greater than the value of metal it contains, it is called token money.
f) Standard Money
This money acts as a reference for estimation of all values. All accounts are maintained in terms of standard money. In Pakistan, the values of a house, a table, wheat or bulb are expressed in rupees. So rupees is our money.
Q.3) Write a note on evolution of money
Answer:
Evolution of money:
The origin of money is little known. History tells us only that very primitive tribes made use of it. Money’s ability to free man from difficulties of barter was a powerful incentive to do so. It is known that all sorts of things have been used as money at one time or another e.g. arrows, hides, animals, precious stones, grains, corals, salt, tobacco, oil, copper, silver, gold, etc.
But even in early civilizations, precious metals slowly replaced all other things as medium of exchange. Gold and silver metals were durable and easily recognizable, divisible and transferable. So these became the common form of money. Until recently, money mostly consisted of these metals. In the seventeenth and eighteenth centuries there was a new and important step in the history of money, i.e. evolution of paper money. This happened like this. People used to keep their gold and silver with the goldsmiths. The goldsmiths, in turn, issued receipts for the gold, ‘promising’ to hand it over on demand. Slowly the people felt that if a person buys something against the payment of gold, the seller might agree to accept, instead of gold, only the receipt of the goldsmith (provided, he thought the goldsmith reliable). As there was much convenience in using these bits of paper instead of gold, the circulation of goldsmiths’ receipts grew wider and wider. Thus, the first paper money was a note Written on some piece of paper in the form of a promise to pay gold on demand. Later with the passage of time, the goldsmiths were replaced by bankers, who specialized in issuing notes. These notes were backed by gold or silver and were convertible on demand into this metal. In the nineteenth century paper money was commonly issued by the commercial banks.
As time went on large scale issuing of notes by commercial banks created confusion and problems. The government had to intervene and regulate money supply. It solved the difficulty by creating central banks and giving the monopoly of note issues to them. Now other banks do not issue notes.
Then history of money took another step forward and deposit money came into being. By the end of the nineteenth century, instead of carrying notes, people started using cheques against their deposits with banks. Deposit money is also called credit money. In payments where big amounts of money are needed, Cheques are more convenient than cash. Thus in all modern economies, this new money i.e. deposit money has become more important and in most drafts. In Pakistan, only 25% of total money supply consists of currency notes. Over past two decades electronic modes of payments and online money has been as follows
Q.4) What is Paper Money? Discuss its merits and demerits
Answer:
Paper money
Paper money means currency notes. The origin of paper money is not very old. It became popular only in the 19th century and rapidly pushed metallic money into the background. In Pakistan, coins are now less than 1% of total money supply. Similarly, all over the world we find that metallic money has been reduced to insignificant role. Paper money has got several advantages over coins although it has some disadvantages too. Main difference between paper money and commodity money is that the commodity has intrinsic value of its own while paper money (a small piece of paper) has no intrinsic value.
Advantages
1. Economical
Due to use of paper money, the governments do not need to acquire huge amounts of gold and silver. Moreover printing paper money is much cheaper than minting coins.
2. Convenient transfer
Paper money is very convenient to transfer from one place to another and from one person to another. A large amount can be easily carried in the pocket, without anybody knowing it.
3. Stability
An important quality of good is its stability of value. The metallic money could not be easily controlled since the government had little control over the supply of metals. But the government can control paper money and keep the value stable. If need arises, it can demonetized notes, as it happened in Pakistan in 1971.
4. Homogeneous
An essential quality of money is that all of its units must be exactly of the same type. Currency notes are all identical to each other. Thus paper money makes a very suitable medium of exchange.
5. Elasticity
Paper money is absolutely elastic. Its quantity can easily be increased or decreased according to the needs of the economy. This problem has been solved through paper money.
6. Advantage to the Government
During wars and national emergencies, the government can increase their resources by printing new notes. Modern governments use the method of deficit financing (increase in money supply) to create funds for development projects.
Disadvantages
1. Inflation
Paper money has a serious defect i.e. there is always a danger of its over.issue. This causes inflation and a fall in the value of money in the country. Imagine the problem faced by the people of Argentina in 1989. The prices were rising 2% daily and were doubling each month. This all was because of paper money used.
2. Difficulty in Foreign Payments
Paper money does not help much outside the country of issue. This causes difficulty in making foreign payments. Contrary to paper money, gold coins are accepted even by foreigners. A few important currencies like the dollar are accepted all over the world, still it is not used in ordinary damage to paper money through fire, flood, white ants and rats.
3. Possibility of Damage
There is always a danger of damage to paper money through fire, flood, white ants and rats.
4. Fake Money
Fake paper money comes into circulation. We may conclude that paper money is a great boon for mankind provided its issue is properly regulated and controlled.
Q.5) What is credit money? Bring out its merits and demerits.
Answer:
Credit money
Credit means confidence of a lender in a borrower’s ability to repay. In simple words, credit means a loan. If a person buys something and does not make immediate cash payment to the seller, we would say that he has brought on credit.
In modern economics more and more business is conducted through credit (bank loans).
The whole banking and insurance structure revolves around the availability of credit.
Advantages
· Purchase Power and Ease of Purchase. Credit cards can make it easier to buy things. If you don’t like to carry large amounts of cash with you or if a company doesn’t accept cash purchases (for example most airlines, hotels, and car rental agencies), putting purchases on a credit card can make buying things easier.
Protection of Purchases. Credit cards may also offer you additional protection if something you have bought is lost, damaged, or stolen. Both your credit card statement (and the credit card company) can vouch for the fact that you have made a purchase if the original receipt is lost or stolen. In addition, some credit card companies offer insurance on large purchases.
· Building a Credit Line. Having a good credit history is often important, not only when applying for credit cards, but also when applying for things such as loans, rental applications, or even some jobs. Having a credit card and using it wisely (making payments on time and in full each month) will help you build a good credit history.
· Emergencies: Credit cards can also be useful in times of emergency. While you should avoid spending outside your budget (or money you don’t have!), sometimes emergencies (such as your car breaking down or flood or fire) may lead to a large purchase (like the need for a rental car or a motel room for several nights.)
· Credit Card Benefits. In addition to the benefits listed above, some credit cards offer additional benefits, such as discounts from particular stores or companies, bonuses such as free airline miles or travel discounts, and special insurances (like travel or life insurance.) While most of these benefits are meant to encourage you to charge more money on your credit card (remember, credit card companies start making their money when you can’t afford to pay off your charges!) the benefits are real and can be helpful as long as you remember your spending limits.
Disadvantages
· Blowing Your Budget. The biggest disadvantage of credit cards is that they encourage people to spend money that they don’t have. Most credit cards do not require you to pay off your balance each month, so even if you only have Rs.100, you may be able to spend up to Rs.500 or Rs.1000 on your credit card. While this may seem like ‘free money’ at the time, you will have to pay it off. and the longer you wait, the more money you will owe since credit card companies charge you interest each month on the money you have borrowed.
· High Interest Rates and Increased Debt. Credit card companies charge you an enormous amount of interest on each balance that you don’t pay off at the end of each month. This is how they make their money and this is how most people in the United States get into debt (and even bankruptcy.) Consider this: If you have a Rs.100 in savings, most banks will give you at the most 2.0 to 2.5% interest on your money over the course of the year. This means you earn Rs.2.00. Rs.2.50 a year on your Rs.100 savings. Most credit cards charge you up to 10 times that amount of interest on balances. This means that if you have a Rs.100 balance that you don’t pay off, you will be charged 20.25% interest on that Rs.100. This means that you owe almost Rs.30 interest (plus the original Rs.100) at the end of the year. A good way to look at this is in comparison to what you would earn in interest from a bank or owe in interest to a bank loan: Savings accounts may pay you around 2% interest; if you have a loan from a bank you may pay them around 10% interest (5 times as much as you earn off your savings); if you owe money to a credit card company, you may pay them around 20% interest (10 times as much as you earn off your savings.)
Credit Card Fraud. Like cash, sometimes credit cards can be stolen. They may be physically stolen (if you lose your wallet) or someone may steal your credit card number (from a receipt, over the phone, or from a Web site) and use your card to rack up debts. The good news is that, unlike cash, if you realize your credit card or number has been stolen and you report it to your credit card company immediately, you will not be charged for any purchases that someone else has made. Even if you don’t realize your credit card number has been stolen (sometimes you might not know until you receive your monthly statement), most credit card companies don’t charge you or only charge a small fee, like Rs.25 or Rs.50, even if the thief has charged thousands of dollars to your card.
Q.6) Define money and what are the sources of supply of money?
Answer:
Money
A current medium of exchange in the form of coins and banknotes; coins and banknotes collectively.
SUPPLY OF MONEY
Supply of money means the total stock of money held by the government, the people and the banking system in the country. It includes all forms of money held by a community at any given moment. The concept of supply of money is quite different from the supply of goods. In the case of goods, supply means the quantity, which is offered, for sale at various prices. People buy goods and consume those. However, the supply of money is the quantity of money held by someone. It circulates and changes hands but the total stock of money remains intact.
In modern economics, supply of money is defined in three different ways.
a) M1= Narrow money or basic Money (currency plus checkable deposits)
b) M2= Monetary Assets (M1 plus time deposits)
c) M3= Broad Money (M2 plus bonds, saving certificates)
FORMS OF MONEY SUPPLY
Money supply in a country has two main parts, currency and bank deposits.
A. Currency
It consists of:
1) Metallic Money or Coins. A small percentage of total money supply is in the form of coins. Before the invention of paper money, the entire money supply consisted of coins.
2) Paper Money or Notes. It is issued by the central bank and circulates as a legal tender. In Pakistan major parts of money consists of notes of various values.
B. Deposit Money ( Credit Money or Bank Money)
These are bank deposits drawable through cheque. Demand deposits (current account) is money by all definitions. Against these deposits, checks are issued to buy goods. In today’s business world, more and more payments are being made through deposit money. Deposit money is also affected by the amount of savings which people put in banks.
M1 (Basic Money Supply) = total amount of currency plus checque-able deposits in the banks
C. Monetary Assets M2
Concept of M2 is wider than M1. When along with currency and checque-able deposits, non checque-able deposits of the banking system are included we get monetary assets known as M2.
D. Broad Money M3
The total sum of monetary assets and near money at a given time in a country are called M3. (or Broad Money).
Near Money
Near money is not money proper. All accounts such as saving accounts, PLS accounts, time deposits (fixed deposits) which can be quickly changed into checque-able deposits are called near money.
Sources of supply of money
There are three main sources of supply of money.
1. Government
Government supplies coins and currency notes, but nowadays this money is a small proportion of the total money supply.
2. Central Bank
Central banks are the most important source of money supply. They have the monopoly of note issuing. For example the State Bank of Pakistan has the responsibility of issuing from 5-rupees notes to 5000-rupees notes. Notes are issued in accordance with rules. The State Bank keeps a minimum amount in the form of gold or foreign currencies as reserve. The notes issued by the State Bank from about ¼ of the total money supply.
3. Commercial Banks
Major part of money supply comes from the commercial banks. It is called deposit money or credit money. A deposit is created when people put their savings in a bank. But in addition to such deposits, the banks themselves “create deposits.” By advancing loans. Under the law, the banks do not have to keep 100% reserves against their deposits. As a result the banks create deposits much in excess of the cash with them. Thus the supply of money in a country depends not only on currency but also on credit policies of the banking system. In Pakistan, banks provide more than 60% of the total supply of money.
Money supply will increase whenever either quantity of currency in circulation increases or bank deposits increase.
MONEY SUPPLY IN PAKISTAN
End April 2011
| Currency in circulation = Rs. 1490 billion (24%) |
| Demand deposits of banks = Rs. 3710 billion (61%) |
| Supply of money (M1) = Rs. 5200 billion (85%) |
Time deposits = Rs. 760 billion (9%)
Residents Foreign Currency Accounts = Rs. 370 billion (6%)
Total Monetary assets (M2) = Rs. 6330 billion (100%)
Growth during year 2010-11 = 14%
Q.7) Explain the meaning of demand for money.
Answer:
Demand for money
Demand for money means the quantity of money which people want to hold at a given time at different rates of interest, other things remaining the same.
We can show the demand for money in a table or graph. It is downward sloping. If rate of interest is lower people prefer to keep money with them in the form of cash.
| RATE OF INTEREST | DEMAND FOR MONEY BILLION RUPEES |
| 12 | 200 |
| 10 | 300 |
| 8 | 400 |
| 6 | 500 |
| 4 | 600 |
Parts of Demand
There are two parts of the demand for money.
A) Transaction demand
B) Asset Demand
A) Transaction demandFirst reason that people want money is that they use it as medium of exchange. Money demanded for this purpose is called Transaction demand. The basic determinant of this demand is level of national income. Higher the income a person has, the more money he needs for his current expenditure Transaction demand for money is not affected by changes of rate of interest.
B) Assets Demand (Portfolio Theory)People hold their financial assets i.e. store their wealth in various forms. They may buy shares of a company or a government bond. One form in which they keep wealth is money form. But since idle money earns no interest, if they are offered good rate of interest they reduce their demand for money as asset and lend some amount. In this way rate of interest has negative relation with money demand.
| Rate of interest | Demand for money |
| 1210864 | 200300400500600 |
The asset demand view was developed by Tobin and others.
Modern economists stress that while deciding how much money a person should keep for transactions, he also has plan about the various forms in which he will put his total wealth. This plan is called portfolio.
In summary, Tobin’s theory states that, “Don’t put all your eggs in one basket”.
Money is not only a medium of exchange or a means of transaction, but also a store of value. Out of many ways of keeping wealth, one is money form. So while deciding his portfolio, a person keeps some of the wealth as money. Suppose a person has a total wealth of 80 lakh and he distributes it in the portfolio as shown in the opposite table. He has 5 lakh in money form, but we know that idle cash does earn nothing. If it is invested in bonds or shares, it will earn some return. For example, he may decide to keep only 3 lakh as cash and put the other 2 lakh also into bonds or saving account. In this way we find that the demand for money is affected by changed in the rate of interest.
Total Demand for Money (billion rupees)
| Rate of interest | Transaction asset demand Total demanddemand for money + for money for money | ||
| 16 | 200 | 100 | 300 |
| 12 | 200 | 200 | 400 |
| 8 | 200 | 300 | 500 |
| 4 | 200 | 400 | 600 |
By putting the figures of this table in a graph, we get the demand for money curve:
Keynes’ view of demand for Money
Keynes counts three motives (or purposes) for which demand for money arises. He calls demand for money as liquidity preference. Liquidity means that an asset is available for some immediate payment. Cash is the most liquid of assets. People prefer to keep their wealth as cash unless a good rate of return is expected from some other form such as bonds
a) Transaction demand people need money to make payments for goods and services. Transaction demand for money is directly related with level of income. More money will be needed at higher income.
b) Speculative demand money is also held to make more money. A person, whose income is more than his current expenditure, has some surplus money. He has two options before him: to keep the money idle with him or lend it and earn interest. At low interest rate people prefer to keep more money with them
c) Precautionary demand it is a minor part of total demand for money. Hold some cash for unexpected expenditure e.g. accident, diseases etc.
Demand for money is affected by income levels
Those initially, income level is Y1 (500 billion) which later to Y2 (800 billion)
| Demand for money ( Rupees in billions) | |
| Rate of interest (%) | At income level Y1 At income level Y2 |
| 16 | 100 160 |
| 12 | 140 200 |
| 8 | 200 260 |
| 4 | 300 360 |
By putting the figures of this table in a graph, we get the demand for money curve:
Q.8) Write notes on:
- a) Discounting Bills.
- b) Insurance companies
- c) Stock Exchange
- d) instruments of credit
- e) Traveller’s cheque
- f) Bill of Exchange
- g) Debenture
Answer:
Discounting bills:
One of the methods of getting working capital is discounting bills with Banks or Financial Institutions. Goods can be sold against advance receipt of money, against payment on delivery or against deferred payment or Credit sales. In case of credit sales, the seller & buyer can have an agreement/understanding wherein, the seller will draw a bill of exchange and the buyer will accept it.
The sale documents & the bill of exchange will generally be exchanged between the parties through their respective banks. In case the seller is in need of money and has credit limits & sub-limits with his/their bank, he/they can get the bill discounted with his bank and take money. The seller/borrower should pay interest on the amount availed against the bill in the name of Bill discounting Charges. Bills will be for a specific period and the bank will extend bill discounting credit for a period not exceeding the due date of the bill. When the customer /buyer pays the money, the same will be adjusted to the credit extended to the seller. Bill facility will be given against domestic as well as export transactions and is a common method of working capital finance. For more knowledge and practical input in the methodology and specifics, approach your bank.
Insurance companies:
Insurance is the equitable transfer of the risk of a loss, from one entity to another in exchange for money. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. An insurer, or insurance carrier, is selling the insurance; the insured, or policyholder, is the person or entity buying the insurance policy. The amount of money to be charged for a certain amount of insurance coverage is called the premium. risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.
The transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer’s promise to compensate the insured in the case of a financial (personal) loss. The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated. Insurance companies conduct and assist all the above mentioned aspects.
Stock exchange:
A stock exchange is an exchange, where stock brokers and traders can buy and/or sell stocks (also called shares), bonds, and other securities. Stock exchanges may also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends. Securities traded on a stock exchange include stock issued by listed companies, unit trusts, derivatives, pooled investment products and bonds. Stock exchanges often function as “continuous auction” markets, with buyers and sellers consummating transactions at a central location, such as the floor of exchange.
Instruments of credit:
Instruments of credit means the methods used to create and use credit.
These include:
1. Book credit is a common practice with local shopkeepers. Where they record your unpaid purchases.
2. Promissory note is a written promise on stamp paper, by the buyer to pay a certain amount to the seller, after a certain period of time.
3. Cheque is an order by a depositor to a bank for paying the amount stated in the cheque.
4. Bank draft is an order of a bank to some other bank to pay the specified amount to the person mentioned in draft.
5. Credit card is issued by a bank as a promise to pay money to the seller from whom the card holder buys something.
6. Bill of exchange (Hundi) is a very convenient instrument for obtaining credit. When a businessman purchases some goods from a seller on credit and promises to make the payment after some time.
7. Security means anything which is offered to the borrower by the lender for getting a loan. Treasury bills, treasury bonds or government bonds are its types.
Traveler’s cheque:
A traveler’s cheque is a medium of exchange that can be used in place of hard currency. Traveler’s cheques are often used by individuals traveling on vacation to foreign countries. Traveler’s cheques can be denominated in one of a number of major world currencies and are preprinted, fixed-amount cheque designed to allow the person signing it to make an unconditional payment to someone else as a result of having paid the issuer for that privilege.
Bill of exchange:
A written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately or on a fixed date for payment of goods and/or services received. The drawee accepts the bill by signing it, thus converting it into a post-dated check and a binding contract.
A bill of exchange is also called a draft but, while all drafts are negotiable instruments only “to order” bills of exchange can be negotiated.
According to the 1930 convention providing a uniform law For Bills of Exchange and promissory note held in Geneva (also called Geneva Convention) a bill of exchange contains:
- 1) The term bill of exchange inserted in the body of the instrument and expressed in the language employed in drawing up the instrument.
- 2) An unconditional order to pay a determined sum of money.
- 3) The name of the person who is to pay (drawee).
- 4) A statement of the time of payment.
- 5) A statement of the place where payment is to be made.
- 6) The name of the person to whom or to whose order payment is to be made.
- 7) A statement of the date and of the place where the bill is issued.
- 8) The signature of the person who issues the bill (drawer). A bill of exchange is the most often used form of payment in local and international trade and has a long history, as long as that of writing.
Debenture:
A debenture is a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term “debenture” originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital. Senior debentures get paid before subordinated debentures, and there are varying rates of risk and payoff for these categories.
Q.9) Differentiate between currency and money.
Answer:
Money is an intangible asset, which means it cannot be touched, it cannot be smelled; however it can be seen in terms of numbers. Money does have a few properties such as it must be a medium of exchange; a unit of account; a store of value; and, occasionally in the past, a standard of deferred payment. Currency is a tangible concept that is based on the intangible money. Currency is the promissory note or coin that is presented in the form of money. Currency is what brings money to life.
Q.10) Describe the difficulties of barter. How money has removed these difficulties?
Answer:
There was a time when money did not exist. People used to exchange goods for goods. Such a system for exchange for goods without the use of money is called barter. This system could work only when the economy was very simple and people produced and used few goods. In rural areas of underdeveloped countries some transactions are still done through barter. Barter had many difficulties and problems. As human civilization advanced, division of labour increased, human wants became diverse and the economic system grew complex, it became very difficult and sometimes impossible to sell and buy goods through barter. For example, in the absence of money, how could a college professor, who can only teach, get food, clothes, petrol, haircut, electricity etc. barter cannot help him to exchange his ‘lecture’ directly with goods. In the money economy, he gets payment for his lecture in rupees which he uses to get all needed goods like petrol and haircut.
DIFFICULTIES OF BARTER
1. Lack of Double Coincidence of Wants
Barter trade requires double coincidence of wants. This is the biggest inconvenience of the barter system, so trade under barter remains limited.
Let us see what double coincidence of wants means. Suppose a person wants to sell some cloth for shoes. Now he must find another person who possesses shoes and is willing to exchange these for cloth (i.e. exchange of goods between two persons A and B can take place only when (i) person B buys what A sells and (ii) he sells what A wants to buy). It is clear that such a type of double coincidence is difficult to find.
2. Lack of Common Measure of Value
In the barter system there is no common measure of valuation. Suppose two persons are ready to exchange goods. But how to determine the relative prices of their goods, (What quantity of one good be given in exchange for the other). The party, which has more urgent and strong desire, will have to suffer by sacrificing a larger quantity of his commodity. This difficulty is faced in another way, whenever any two parties make a deal, each time, they will have to settle the terms of exchange afresh.
3. Indivisibility of Goods
Many goods are not divisible. Sometimes this fact becomes an obstacle in exchange. For example, a person possesses a chair and wants to get a pen. The value of a chair is much more than one pen. Barter cannot solve this problem.( only money can help to overcome this difficulty. Chair will be sold for rupees and then buy a pen).
4. Difficulty in Storing of Value
Many times people need to store value (e.g. wheat). They want to save a part of their current income. However, in the absence of money it will be difficult. Suppose a farmer produces surplus wheat. He desires to store a part of this wheat for his old age. But it is impossible for him to do so. Wheat will be wasted after a year or two.
Similar is the case with many other commodities.
5. Difficulty in Borrowing and lending
In a barter economy, borrowing and lending of goods also become difficult. For example a person lends some quantity of wheat during a period of famine. Now if the same quantity of wheat is returned during the times when wheat is in abundance. Naturally he will be a sufferer.
6. Difficulties in Government Taxes and Payments
If there is no money, the government will have to collect taxes in kind and pay its employees in the same form. But how absurd it would be that the state is receiving its share and paying salaries in the form of fruit, milk, eggs. Wheat, cloth, and shoes.
7. Difficulty in Transfer of Wealth
This difficulty arises when someone intends to shift his wealth from one place to another. It is almost impossible to find a person in another city who can exchange his property against yours in one city.
Replacement of barter system by money
The Barter System was vulnerable to many defects and difficulties in an economy but with Currency Money these problems were solved. Below are the benefits that people enjoy from Currency Money.
1. Double Coincidence of Wants:
Money as a medium of exchange has removed the double coincidence of wants. Under monetary systems money is exchanged for goods and services when people buy things. Goods and services are exchanged for money when people self-things, there is no necessity for a double coincidence of wants in the presence of money.
A man with wheat who wants to purchase oil, needs not to find a person who has oil and wants wheat. He can sell his wheat in the market for money and then purchase oil with the money thus obtained.
2. Common Measure Of Value:
Money has overcome the difficulty of common measure of value by acting as a standard of value. In a money economy the value of any commodity can easily be expressed in terms of money.
3. Store Of Value:
Money has removed the difficulty of store of value. Money is used to store the value (wealth) of goods and services. One can store one’s earning in terms of money without any difficulty.
4. Future Payments:
Money has overcome the difficulty of future payments. Debts and future payments are stated in terms of money. There is no problem in receiving and making payments in future.
5. Sub Division:
Money has solved the problem of sub-division of commodities as money is easily divisible. With the help of money one can exchange individual commodities of great value for a commodity of less value. Money has made it possible to buy goods of both high and low value.
6. Transfer of Value:
Money has made easy the transfer of wealth from one place to another place. A person can sell his immovable and movable property or things at one place and transfer his wealth to another place in terms of money.
The Barter System was vulnerable to many defects and difficulties in an economy but with Currency Money these problems were solved. Below are the benefits that people enjoy from Currency Money.
1. Double Coincidence of Wants:
Money as a medium of exchange has removed the double coincidence of wants. Under monetary systems money is exchanged for goods and services when people buy things. Goods and services are exchanged for money when people self-things, there is no necessity for a double coincidence of wants in the presence of money.
A man with wheat who wants to purchase oil, needs not to find a person who has oil and wants wheat. He can sell his wheat in the market for money and then purchase oil with the money thus obtained.
2. Common Measure Of Value:
Money has overcome the difficulty of common measure of value by acting as a standard of value. In a money economy the value of any commodity can easily be expressed in terms of money.
3. Store Of Value:
Money has removed the difficulty of store of value. Money is used to store the value (wealth) of goods and services. One can store one’s earning in terms of money without any difficulty.
4. Future Payments:
Money has overcome the difficulty of future payments. Debts and future payments are stated in terms of money. There is no problem in receiving and making payments in future.
5. Sub Division:
Money has solved the problem of sub-division of commodities as money is easily divisible. With the help of money one can exchange individual commodities of great value for a commodity of less value. Money has made it possible to buy goods of both high and low value.
6. Transfer of Value:
Money has made easy the transfer of wealth from one place to another place. A person can sell his immovable and movable property or things at one place and transfer his wealth to another place in terms of money.
