Supply of Money
Hey Mumbai University SYBA IDOL students! Today, we’re diving into the fascinating world of Macro Economics , exploring the chapter – “Supply of Money“. Here’s what we are going to cover:
First, we’ll explore the meaning of money and understand its main functions. We’ll discuss how money acts as a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. Next, we’ll explain the concept of money supply, examining how the total amount of money in circulation within an economy is determined.
Following that, we’ll identify the determinants of money supply, looking at factors such as the banking system, the central bank’s policies, and the public’s demand for cash versus deposits.
We will also explain the concept of the velocity of circulation of money, understanding how quickly money changes hands within an economy and its implications for economic activity.
Finally, we’ll explain the RBI’s approaches to measurement of money supply, exploring the different measures like M1, M2, M3, and M4, and how the Reserve Bank of India uses these measures to assess and manage the economy.
So, SYBA IDOL Mumbai University students, get ready to unwrap the mysteries of “Supply of Money” with customized IDOL notes just for you. Let’s jump into this exploration together.
Question 1:- What is the meaning of money? What are the main functions of money?
Introduction:
Money is a fundamental concept in economics, playing a critical role in the functioning of any economy. Alfred Marshall described money as anything widely accepted for buying goods and services. Understanding the meaning of money and its functions is crucial for grasping how economic transactions take place and how economies operate efficiently.
Meaning of Money:-
- Marshall’s Definition: Money includes all things generally accepted without doubt as a means of purchasing commodities and services. This encompasses coins, notes, and demand deposits with commercial banks.
- Money Supply: Money supply refers to the total amount of money available in an economy for spending. It includes coins, notes, and the money people have in their bank accounts.
Functions of Money:
- Medium of Exchange
- Explanation: Money is used to buy and sell goods and services. This eliminates the need for barter transactions, where goods and services are directly exchanged without money.
- Example: Instead of trading a cow for wheat, people can use money to buy what they need.
- Measure of Value
- Explanation: Money acts as a common measure of value for all commodities and services. It makes it easier to compare the value of different items.
- Example: Knowing that a book costs Rs. 200 and a shirt costs Rs. 400 helps compare their values.
- Store of Value
- Explanation: Money allows people to store value for future use. It is durable and can be easily exchanged for other goods and services when needed.
- Example: Saving money today means it can be used to buy goods and services in the future.
- Standard of Deferred Payments
- Explanation: Money enables future payments to be expressed in monetary terms, facilitating credit transactions in modern economies.
- Example: Borrowing Rs. 1000 today with the promise to pay it back with interest in the future.
Importance of Money:
- Facilitating Transactions: Money simplifies transactions, making it easier for people to buy and sell goods and services.
- Economic Stability: A stable money supply helps maintain economic stability, allowing people to save and plan for the future.
- Efficient Resource Allocation: Money helps in the efficient allocation of resources by acting as a signal for what is valued in the economy.
Conclusion:
Money is a vital component of any economy, facilitating transactions, providing a measure of value, storing value for future use, and enabling deferred payments. Understanding the meaning of money and its functions helps us appreciate its essential role in economic activities and stability. By acting as a medium of exchange, a measure of value, a store of value, and a standard of deferred payments, money makes economic transactions smooth and efficient, contributing significantly to the overall health of the economy.
Question 2 :- Explain the concept of money supply
Introduction:
Money supply is a crucial concept in economics, representing the total amount of money available in an economy for spending purposes. It includes various forms of money held by individuals and institutions, influencing economic activities and policy decisions.
- Definition of Money Supply: Money supply refers to the total stock of money available in an economy at a given point in time. It encompasses different types of money, such as coins, government-issued notes (legal tender), and deposits held with banks.
- Components of Money Supply:
a. Narrow Money (M1): This includes currency (notes and coins) in circulation among the public and demand deposits held in banks, which can be withdrawn without prior notice.
b. Broad Money (M2, M3): Beyond M1, broad money incorporates time deposits (savings accounts) and less liquid assets, providing a broader view of money available for spending. - Exclusions from Money Supply: Certain financial assets are excluded from the definition, such as currency held by banks as reserves, monetary gold held internationally, and cash balances not used for commercial transactions.
- Significance of Money Supply: Understanding money supply helps in assessing an economy’s liquidity and financial health. It directly influences economic activities like consumption and investment, as well as inflation rates and the effectiveness of monetary policies.
- Role of Central Banks: Central banks monitor and manage money supply to stabilize prices and support economic growth. They use tools like open market operations and reserve requirements to regulate the amount of money circulating in the economy.
Conclusion:
The concept of money supply encompasses all forms of money available for transactions in an economy. Its management by central banks is crucial for maintaining economic stability and promoting sustainable growth. By controlling money supply, policymakers aim to achieve price stability and enhance overall economic performance.
Question 3 :- What are the determinants of money supply?
Introduction:
The total money available in an economy is influenced by several factors known as determinants of money supply. These factors play a crucial role in shaping the amount of money circulating in an economy, affecting economic activities and policy decisions.
- High Powered Money: High powered money includes currency, bank reserves, and deposits with the central bank. It forms a significant part of money supply as it directly affects how much money banks can lend and circulate in the economy.
- Money Multiplier:
a. Public Preference: People’s choice to hold cash versus depositing money in banks impacts the money multiplier. When more money is deposited in banks, it increases the potential for lending and thus expands the money supply.
b. Reserve Requirements: Regulations on how much banks must keep in reserves affect how much they can lend out. Lower reserve requirements can lead to a higher money multiplier and increased money supply. - Community’s Choice: The community’s decision on whether to hold money in cash or deposit it in banks influences credit creation and the overall money supply. Money kept in banks is used for loans, which in turn affects how much money is available for spending in the economy.
- Velocity of Circulation: Velocity of money refers to how quickly money changes hands in transactions. A higher velocity means money is used more frequently, effectively increasing its impact on the economy and contributing to a higher money supply.
- Fiscal and Monetary Policy:
a. Fiscal Policies: Government decisions on taxes, spending, and borrowing influence the amount of money circulating in the economy. For example, increased government spending can inject more money into circulation.
b. Monetary Policies: Central banks use tools like interest rates and open market operations to control money supply. Lowering interest rates encourages borrowing and spending, thereby increasing money supply.
Conclusion:
The determinants of money supply are critical factors that shape the availability of money in an economy. By understanding and managing these factors, policymakers can aim to achieve economic stability, promote growth, and effectively regulate inflation. These determinants highlight the complex interplay between individual choices, regulatory policies, and economic dynamics in determining the overall money supply.
Question 4 :- Explain the concept of velocity of circulation of money
Introduction:
The velocity of circulation of money is a key concept in economics that refers to how quickly money changes hands within an economy over a specific period, usually a year. It helps us understand the relationship between the money supply and economic activity.
- Impact on Money Supply: The velocity of money affects the total money supply in the economy. When money moves quickly from one transaction to another, it increases the effective money supply, making more money available for spending and investment.
- Factors Affecting Velocity:
a. Regularity of Income: When people receive income regularly, they tend to spend it quickly. This increases the speed at which money circulates in the economy.
b. Liquidity Preference: Liquidity preference is the desire to hold cash. If people prefer to keep their money in cash rather than spend it, the velocity of money decreases.
c. Savings: When people save more and spend less, the velocity of money decreases. Less money circulates in the economy, which can slow down economic activity.
d. Development of Banking: In countries with well-developed banking systems, money can move more efficiently through financial institutions. This tends to increase the velocity of money.
e. Trade Cycles: Economic cycles also affect the velocity of money. During periods of economic prosperity, money circulates more quickly. During recessions or deflationary periods, the velocity of money slows down. - Relationship with Money Supply: The velocity of money, together with the money supply, determines the level of economic activity and inflation. A higher velocity can lead to more economic growth, while a lower velocity may indicate an economic slowdown.
- Policy Implications: Central banks and policymakers consider the velocity of money when creating monetary policies. Changes in velocity can affect how well these policies control inflation or stimulate economic growth.
Conclusion:
The velocity of circulation of money is essential for understanding how money moves within an economy and its impact on economic performance. By analyzing the velocity of money, economists and policymakers can better manage economic activities and achieve goals like stable growth and controlled inflation.
Question 5 :- Explain the RBI’s Approaches to measurement of money supply
Introduction:
The Reserve Bank of India (RBI) uses different methods to measure the money supply in the Indian economy. These methods help understand the amount of money available for spending and investment, which is crucial for assessing economic conditions and making policy decisions.
- Narrow Money (M1): Narrow money, known as M1, includes the most liquid forms of money. It consists of:
- Currency held by the public: The money people have in their hands.
- Demand deposits with commercial banks: Money in bank accounts that can be withdrawn without prior notice.
- Other deposits with the RBI: Small deposits with the central bank.
- Broad Money (M3): Broad money, known as M3, includes everything in M1 plus:
- Time deposits with commercial banks: Money kept in fixed deposits and savings accounts, which are less liquid but still part of the money supply.
- Four Measures of Money Supply: The Second Working Group on Money Supply, accepted by the RBI in 1977, introduced four measures of money supply:
- M1: Currency with the public + Demand deposits with commercial banks + Other deposits with the RBI.
- M2: M1 + Post Office Savings Bank Deposits.
- M3: M1 + Time deposits with commercial banks.
- M4: M3 + Total Post Office Deposits (excluding National Savings Certificates).
- Importance of Narrow and Broad Money: Both narrow money (M1) and broad money (M3) are important. Narrow money includes only the most liquid assets, while broad money includes less liquid assets like time deposits. This helps in understanding different aspects of the money supply.
- Third Working Group Recommendations: In 1998, the third working group on money supply recommended two additional measures:
- M0: Currency in circulation + Bankers’ deposits with the RBI + Other deposits with the RBI.
- M1: Currency with the public + Demand deposits with the banking system + Other deposits with the RBI.
Conclusion:
By using these measures, the RBI can monitor the liquidity in the economy, evaluate the effectiveness of monetary policies, and make informed decisions to maintain price stability and support economic growth. These methods provide a comprehensive view of the money supply, helping policymakers manage the economy more effectively.
Important Note for Students :– Hey everyone! All the questions in this chapter are super important!