Quiz 29: Money and the Banking System

Business

Barter system Barter system refers to the transaction of goods for goods. Goods or services are exchanged for one another in the absence of any medium of exchange, such as, money. For instance, a wheat producer who demands rice exchanges wheat for rice. Barter system and education On demand for education under the barter system, a student would pay his tuition fees by performing services and favoring the management with goods. • The student may give food articles, furniture, and durables to the management in order to pay the tuition fees. • The student may perform services to the management such as cleaning, cooking, and so on. If no goods and services are accepted If a college does not accept the above favors of goods and services, then the student has no other option but to study in the absence of a medium of exchange. Therefore, he has to either study by himself with the available resources or he has to give up education. A medium of exchange is necessary since all the goods or services do not have equivalent measures. Thus, introduction of money is significant to overcome these hurdles.

Money multiplier Money multiplier refers to the effect of change in money supply due to a change in the money base. Change in the money supply Assume in an economy, banks have no excess reserves and public or firms do not hold cash in hand. A person gets $12 million worth of treasure and deposits that amount in the bank with a 10 percent of required reserve ratio. To calculate the money supply, substitute the above details in Equation (1): img ……(1) Where, img money supply D = change in the deposit m = required reserve ratio img The deposit of $12 million with the required reserve ratio of 10 percent leads to an increase in the money supply by 10 times of the deposit, that is, $120 million.

Money Conceptually, money is manmade and it is used as a medium of exchange against goods or services. The value of any commodity is usually measured by the quantity of money. The following discussion elucidates the practical use of money. Functions of money The functions of money have been classified as follows: • Medium of exchange • Store of value • Measure of value Medium of exchange In ancient times, commodities were exchanged against other commodities with mutual concern of commodity. This is known as barter system. However, there was only a limited transaction of goods due to mutual concern. The barrier of mutual concern is ruled out by the introduction of money. Money serves as a medium of exchange of commodity transaction. People can sell their goods for money and buy other goods from other people using the money. Hence, it speeds up the transaction of goods. Medium of exchange is the primary function of money. Store of Value The other important function of money is store of value. Excess purchasing power can be saved through money. People can buy any asset, commodity, or service in future using the money. The value of money may fluctuate, but people will prefer to keep this form of money due to its high liquidity than the other assets. This serves as store of value which facilitates savings. Measure of value All the commodities and services are measured in terms of money. This common unit of measurement facilitates the record of accounting procedure and comparison of prices of various goods and services in the market. Fiat money Fiat money refers to the money legally accepted and issued by the government which does not have any intrinsic value. All paper money is an example of fiat money. The paper which is used for printing $100 does not possess any value. Full-bodied paper money Full-bodied paper money refers to the certificates backed by gold or silver, where the paper value is equivalent to the value of gold or silver. Commodity money Commodity money refers to the money which retains some value even if it is altered in a different form. Gold, silver and other metal coins are examples of commodity money. Even after melting these coins, some value is retained. U.S. money supply and types of money Throughout history, U.S. money supply has consisted of the above types of money. Commodity money was dominated by full-bodied money, and partial paper money was backed by full-bodied paper money. The introduction of fiat money dominated the full-bodied paper money; now, U.S. money supply consists of only fiat money.

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