B.Com(H)- 5th Sem.

Unit-1st
Monetary Theories and Institutions

● Money and Money Standards

● Money
Introduction:
The money came into existence to overcome the drawbacks of the barter
system. Earlier, people used to exchange goods and services as a form of
commerce. This often led to many disadvantages, one of which was the
double coincidence of wants. To solve this problem, a standard medium of
exchange, money, was introduced.

Meaning:
A medium of exchange that is centralized, generally accepted, recognized,
and facilitates transactions of goods and services, is known as money.
● Money is a medium of exchange for various goods and services in an
economy.
● The money system varies with the governments and countries.
● Different countries have different currencies.
● The central authority is responsible for monitoring the monetary
system.
● There are many forms of money, and cryptocurrency is the newest
addition to the forms of money and can be internationally exchanged.

Definition of Money
Money refers to any medium of exchange that is widely accepted in
transactions for goods and services. It can take the form of physical
currency, such as coins and banknotes, or electronic currency, such as
digital payments or bank deposits. Money serves as a store of value, a unit
of account, and a medium of exchange in economic transactions. It is an
essential component of modern economies and plays a critical role in
facilitating trade and commerce.

Nature / Characteristics / Features of Money

The nature of money can be described through the following
characteristics:
1. Medium of exchange: Money is widely accepted as a means of
payment in exchange for goods and services.
2. Store of value: Money serves as a store of value, allowing individuals to
save and accumulate wealth over time.
3. Unit of account: Money is used as a standard unit of measurement for
the value of goods and services.
4. Portable: Money is easily transportable and can be carried around in
small quantities.
5. Divisible: Money can be divided into smaller units, making it easier to
exchange for goods and services of varying values.
6. Durable: Money must be able to withstand wear and tear and maintain
its value over time.
7. Acceptable: Money must be widely accepted by individuals and
institutions as a means of payment.
8. Limited in supply: The supply of money must be limited to maintain its
value and prevent inflation.
9. Legal tender: Money is recognized as a legal means of payment by
governments and institutions.
10. Fungible: Money is interchangeable, meaning that one unit of currency
is equal in value to any other unit of the same currency.

Functions of Money
The functions of money can be broadly categorized into three main
categories:
1. Medium of exchange: Money serves as a medium of exchange for
goods and services. It allows individuals to trade one good or service for
another without the need for barter or direct exchange.
2. Store of value: Money serves as a store of value, allowing individuals to
save and accumulate wealth over time. It can be used to purchase goods
and services in the future, or to invest in assets that can appreciate in
value.
3. Unit of account: Money is used as a standard unit of measurement for
the value of goods and services. It allows individuals to compare the value
of different goods and services, and to make informed decisions about how
to allocate their resources.
Other functions of money may include:
4. Standard of deferred payment: Money can be used to settle debts or
make payments in the future, allowing individuals to make purchases on
credit.
5. Means of exchange: Money can be used to facilitate international trade
and exchange, allowing individuals to purchase goods and services from
other countries.
6. Measure of economic activity: Money can be used as a measure of
economic activity, allowing policymakers to track economic growth and
make informed decisions about monetary policy.
Overall, the functions of money are essential for the functioning of modern
economies, as they facilitate trade, investment, and economic growth.

Importance of Money in Capitalist Economy

Money plays a critical role in a capitalistic economy, which is based on the
principles of private ownership, profit motive, and market competition. Here
are some of the key reasons why money is so important in a capitalistic
economy:
1. Facilitating trade: Money serves as a medium of exchange, allowing
individuals and businesses to trade goods and services with one another.
This is critical for the functioning of a market-based economy, as it allows
for the efficient allocation of resources and the specialization of labor.
2. Encouraging investment: In a capitalistic economy, individuals and
businesses are incentivized to invest their money in productive assets that
can generate a return. This investment is critical for economic growth and
innovation, as it allows new businesses and technologies to emerge.
3. Enabling savings: Money also serves as a store of value, allowing
individuals to save and accumulate wealth over time. This is important for
retirement planning, education, and other long-term goals.
4. Promoting competition: Money plays a key role in promoting market
competition, as it allows businesses to compete for customers on the basis
of price, quality, and other factors. This competition helps to drive
innovation, improve efficiency, and lower prices for consumers.
Overall, the importance of money in a capitalistic economy cannot be
overstated. It is a critical tool for facilitating trade, encouraging investment,
enabling savings, and promoting competition, all of which are essential for
economic growth and prosperity.

Importance of Money in Socialist Economies

In a socialist economy, money plays a different role than it does in a
capitalist economy. Here are some of the key ways in which money is
important in a socialist economy:

1. Facilitating exchange: Similar to a capitalist economy, money serves as

a medium of exchange in a socialist economy. It allows individuals and
businesses to trade goods and services with one another, and helps to
facilitate the allocation of resources.

2. Ensuring fair distribution: In a socialist economy, the goal is to ensure

that wealth and resources are distributed more equally among all members
of society. Money can play a role in achieving this goal by serving as a tool
for redistributing wealth through taxes, subsidies, and social programs.

3. Supporting public goods: In a socialist economy, there is often a

greater emphasis on public goods and services, such as healthcare,
education, and infrastructure. Money is important for financing these public
goods, as it allows the government to collect taxes and other revenues to
fund these programs.
4. Limiting the influence of markets: In a socialist economy, there may
be less reliance on market mechanisms to allocate resources. Money can
play a role in limiting the influence of markets by allowing the government
to set prices, regulate industries, and control the money supply.

Overall, money plays an important role in a socialist economy, but it is used

in a different way than in a capitalist economy. Instead of serving primarily
as a tool for promoting economic growth and competition, money is used to
support social goals such as equality, public goods, and government
intervention in the economy.

Metallic Money

Meaning :
Metallic money refers to coins that are made of metal, usually precious
metals like gold, silver, and copper. It is a physical representation of the
value of money and can be used as a medium of exchange to purchase
goods and services. Metallic money has been used as a form of currency
for centuries and is still in use today in many countries around the world.
The value of metallic money is determined by the weight and purity of the
metal it is made of, and it is often considered to have intrinsic value
because of this.
Merits of Metallic Money
Here are some of the merits of metallic money:

1. Durability: Metallic money is durable and can last for a long time without
losing its value. This makes it a reliable form of currency that can be used
over and over again.

2. Intrinsic value: Metallic money has intrinsic value because it is made of

precious metals like gold and silver. This means that it has value even if it
is not used as a currency, making it a good investment option.

3. Acceptance: Metallic money is widely accepted and recognized as a

form of currency around the world. This makes it a convenient form of
currency for international trade.

4. Easy to carry: Metallic money is easy to carry and transport, making it a

convenient form of currency for everyday transactions.
5. Protection against inflation: Because metallic money has intrinsic
value, it is protected against inflation. This means that its value is less likely
to be eroded over time.

6. Security: Metallic money is difficult to counterfeit, making it a secure

form of currency that is less vulnerable to fraud.

Overall, metallic money has many merits that make it a reliable and
convenient form of currency. Its durability, intrinsic value, and wide
acceptance make it a popular choice for investors and consumers alike.

Demerits of Metallic Money

1. Heavy: Metallic money can be heavy to carry around, especially in large
amounts.

2. Prone to theft: Metallic money can be easily stolen, making it a target

for thieves and robbers.

3. Cost of production: The cost of producing metallic money can be high,

especially for smaller denominations.

4. Wear and tear: Metallic money can wear and tear over time, making it
less valuable and less useful.

5. Inconvenient for larger transactions: Metallic money can be

inconvenient for larger transactions, as it may require multiple coins or bills
to make a purchase.

6. Counterfeiting: Metallic money can be counterfeited, which can cause

economic instability and loss of trust in the currency.

7.Cost: Producing metallic money can be expensive, especially if the coins

are made of precious metals like gold and silver.

8. Availability: Precious metals used to make metallic money can be

scarce, making it difficult to produce enough coins to meet demand.
 ● Gold Standards

Meaning
The gold standard is a monetary system in which a country's currency or
paper money has a value directly linked to gold. Under the gold standard, a
country's currency is convertible into a fixed amount of gold at a determined
price. This means that the monetary policy of a country is tied to the
amount of gold reserves it holds. The gold standard was widely used in the
19th and early 20th centuries, but it has largely been abandoned in favor of
fiat currency systems, in which the value of a currency is not directly linked
to a physical commodity such as gold.

Advantages of Gold Standards

1. Stability: Gold standards provide stability to the economy. The value of

gold is relatively stable and does not fluctuate as much as fiat currencies.
This means that prices of goods and services are also more stable, making
it easier for businesses and consumers to plan and invest.

2. Inflation control: Since the supply of gold is limited, its value does not
decrease due to inflation. This means that gold standards can help control
inflation and prevent the erosion of purchasing power.

3. Confidence: Gold has been a trusted store of value for thousands of

years. Adopting a gold standard can instill confidence in the economy and
the currency, as people trust that their money will hold its value over time.

4. International trade: Gold standards can facilitate international trade by

providing a common currency that is widely accepted. This can reduce the
need for currency exchange and make trade more efficient.

5. Fiscal discipline: Gold standards can encourage fiscal discipline by

limiting the government's ability to print money and run up debt. This can
help prevent economic crises caused by excessive government spending.

6. Transparency: Gold standards can provide transparency in monetary

policy by making it clear how much gold backs each unit of currency. This
can increase trust in the government and reduce the risk of corruption or
manipulation.
7. Long-term stability: Gold standards can provide long-term stability to
the economy, as the value of gold tends to appreciate over time. This can
encourage long-term investment and growth.

Disadvantages of Gold Standards

1. Limited money supply: Under the gold standard, the money supply is
limited by the amount of gold reserves held by the central bank. This can
restrict economic growth and limit the availability of credit.
2. Economic instability: The gold standard can lead to economic
instability, as fluctuations in the supply of gold can cause deflation or
inflation.
3. Limited flexibility: Under the gold standard, the central bank has limited
flexibility to respond to economic shocks and crises. This can make it
difficult to stabilize the economy in times of crisis.
4. Inefficient allocation of resources: The gold standard can lead to an
inefficient allocation of resources, as it encourages countries to focus on
producing and exporting gold rather than other goods and services.
5. Vulnerability to hoarding: The gold standard is vulnerable to hoarding,
as individuals and countries may choose to hold onto their gold reserves
rather than investing them in the economy.
6. Lack of control over interest rates: The gold standard limits the ability
of central banks to control interest rates, which can make it difficult to
manage inflation and promote economic growth.

Kinds of Gold Standards

There are two types of Gold Standards-
1. Classical Gold Standard: This was the first type of gold standard,
which came into existence in the 19th century. Under this system, the value
of a country's currency was directly linked to a fixed amount of gold. The
central bank of the country had to maintain enough gold reserves to back
up its currency. The exchange rate between two currencies was determined
by the relative value of their gold content.
2. Gold Exchange Standard: This system was introduced in the 20th
century and was used by most countries until the mid-20th century. Under
this system, instead of directly backing up their currency with gold,
countries would hold their reserves in the form of foreign currencies that
were convertible to gold. The US dollar was the most widely used currency
for this purpose, and the exchange rate between currencies was
determined by their relative value to the US dollar.

Causes for abandonment of Gold Standard

There were several reasons for the abandonment of the gold standard:

1. The Great Depression: The Great Depression of the 1930s led to a

decline in economic activity and a decrease in the demand for gold. This
caused many countries to abandon the gold standard as they could not
maintain the fixed exchange rates.

2. World War I: The cost of World War I led many countries to abandon the
gold standard as they needed to print more money to finance the war,
which led to inflation.

3. International trade: The gold standard made international trade difficult,

as it required countries to maintain a fixed exchange rate with gold, which
could be difficult to manage.

4. Economic growth: As economies grew, the demand for money

increased, and the supply of gold could not keep up, leading to a shortage
of money and a need to abandon the gold standard.

5. Currency speculation: Currency speculators could cause a run on a

country's gold reserves, forcing it to abandon the gold standard.

6. Political pressure: Political pressure from interest groups and political

leaders could force a country to abandon the gold standard.

7. The Bretton Woods Agreement: The Bretton Woods Agreement of

1944 established a new international monetary system based on the US
dollar, which was backed by gold. However, the US government eventually
abandoned the gold standard in 1971, leading to the collapse of the
system.

● Paper Money
Meaning of paper Money
Paper money, also known as banknotes or currency, is a type of legal
tender that is made of paper or polymer and is issued and regulated by the
government and central bank of a country. It is used as a medium of
exchange for goods and services and is widely accepted by individuals and
businesses within that country. The value of paper money is based on the
trust and confidence people have in the government and central bank that
issues it. Unlike commodity money such as gold or silver coins, paper
money does not have intrinsic value but its value is determined by the
government's ability to maintain its stability and credibility.

Merits of Paper Money :

1. Convenience: Paper money is more convenient to carry around than
coins or other forms of currency, making it easier to conduct transactions.

2. Easy to produce: Unlike commodity money, paper money is easy and

inexpensive to produce, which makes it more accessible to people.

3. Reduced risk of theft: Paper money is less likely to be stolen than other
forms of currency, as it is easier to hide and protect.

4. Inflationary control: Governments can control inflation by regulating the

amount of money that is printed and circulated.

5. Facilitates international trade: Paper money makes it easier to conduct

international trade as it is universally accepted.

Demerits of Paper Money

1. Inflation: The biggest disadvantage of paper money is that it can lead to

inflation. When the supply of paper money increases, it reduces its value,
leading to higher prices of goods and services.

2. Counterfeiting: Paper money is vulnerable to counterfeiting, which can

lead to a loss of faith in the currency and a decrease in its value.

3. Loss of value: Paper money does not have intrinsic value like gold or
silver coins. Its value is based on the trust people have in the government
and the central bank that issues it. If this trust is lost, the value of the
currency can decrease rapidly.

4. Need for security: Paper money needs to be secured against theft and
loss, which can be expensive and time-consuming.

5. Difficulty in handling: Paper money can be difficult to handle in large

amounts, especially when making large transactions.

6. Not universally accepted: Paper money is not universally accepted,

especially in rural areas or in countries with low levels of economic
development.

7. Environmental impact: The production of paper money has an

environmental impact, as it requires the use of natural resources and
energy.

8. Risk of government interference: Governments can manipulate the

value of paper money for political or economic reasons, which can lead to
instability and uncertainty.

Methods of Issue of Paper Money

Notes are issued in almost all the countries according to the “Banking
Principal”, but the reserve varies from country to country. According to the
reserve, several countries methods of note issued have been evolved
which are as under;
● Fixed Fiduciary System
● Maximum Fiduciary System
● Proportional Reserve System
● The Minimum Reserve System
1. Fixed Fiduciary System
Under this method of note issue, the central bank of the country is allowed
to issue currency notes of a specified amount without presenting gold and
silver to cover it. Once this limit is reached, an additional amount of notes
can be issued by hundred percent backed by gold. The advantages
claimed for this method is that it gives elasticity in the money supply. It also
grants maximum care due to the excess issuance of notes of the “Fiduciary
Limit” except they are sheltered by hundred percent of gold. The possibility
of inflation is effectively checked. However, this system is objected to on
the ground that the judiciary limit is open to change by amendment in the
Act and is raised will lose the confidence of the people.
2. Maximum Fiduciary System
According to this method of note issue, the fiduciary system’s limit is fixed
above the normal requirements of the country. Beyond the maximum no
note is issued without legal sanction. This system is defective in the sense
that, if the limit is too low, the currency system becomes inelastic and if the
limit is too high, there is danger of over issue of notes.
3. Proportional Reserve System
Under this method of note issuance, the central bank is mandated by law to
maintain a permanent percentage from 25% to 40% adjacent to issuance of
notes. It is often called the percentage system. The remainder of the notes
is to be covered by trade bills and government securities. This system is
easily operated and it gives needed elasticity to the currency note system.
But the system is uneconomic as huge amounts of gold are kept idle as
reserve. Moreover, the value of money is not stable, but this system is
elastic up to a certain limit.
4. Minimum Reserve System
Under this method of note issue, the reserve limit is permanently fixed and
the volume of the notes has no connection with the amount of the reserve.
To meet the ever- increasing demand for currency, the government can
issue notes up to any amount against the reserve but it is faced with the
danger of inflation.

Important Question
1. What do you mean by Money? Explain its various features.
2. What do you mean by Money ? Explain various functions of money.
3. Explain the importance of money in a Capitalist Economy.
4. Explain the importance of money in a Socialist Economy.
5. What do you mean by Metallic Money ? Give its Merits and Demerits.
6. What do you mean by Gold Standard ? Give its Advantages and
disadvantages.
7. Explain various kinds of Gold Standard. Also Explain Various causes
of its abandonment.
8. What do you mean by Paper Money ? Give its Merits and Demerits.
9. Explain Various methods of issue of Paper Money.

MCQS
1.Which of the following statements is true about the Indian monetary system?
a.The Indian monetary system is based on the gold standard
b.The Indian monetary system is based on the credit money standard
c.The Indian monetary system is based on the paper standard
d.The Indian monetary system is based on the metallic standard
Answer: c
2.Which agency regulates the money supply in India?
a.The Government of India
b.Commercial banks
c.Reserve Bank of India
d.None of the above
Answer: c
3. What is the definition of money?
A. A medium of exchange
B. A store of value
C. A unit of account
D. All of the above
Answer: D
4. Which of the following is NOT a function of money?
A. Medium of exchange
B. Store of value
C. Unit of production
D. Unit of account
Answer: C
5. Which of the following is NOT a characteristic of money?
A. Portability
B. Durability
C. Indivisibility
D. Divisibility
Answer: C
6. Which of the following is an example of fiat money?
A. Gold coins
B. Silver bars
C. Paper currency
D. All of the above
Answer: C
7. Which of the following is NOT a type of money?
A. Commodity money
B. Representative money
C. Digital money
D. Inflationary money
Answer: D
8. Which of the following is an example of representative money?
A. Gold coins
B. Silver bars
C. Paper currency backed by gold
D. Paper currency backed by silver
Answer: C
9. Which of the following is NOT a benefit of using money?
A. Efficiency in transactions
B. Standardization of value
C. Protection against inflation
D. Facilitation of economic growth
Answer: C
10. Which of the following is an example of a store of value?
A. A house
B. A car
C. A bank account
D. All of the above
Answer: C
11. Which of the following is NOT a feature of a good currency?
A. Acceptability
B. Scarcity
C. Durability
D. High inflation rate
Answer: D
12. Which of the following is an example of digital money?
A. Credit cards
B. Debit cards
C. PayPal
D. All of the above
Answer: D
13. What is the most common form of money?
a) Gold
b) Paper money
c) Bitcoin
d) Silver
Answer: b) Paper money
14. Which of the following is not a function of money?
a) Medium of exchange
b) Store of value
c) Unit of account
d) All of the above are functions of money
Answer: d) All of the above are functions of money
15. What is money?
a) A medium of exchange
b) A store of value
c) Both a and b
d) None of the above
Answer: c) Both a and b
16. What is the advantage of paper money over commodity money?
A. Paper money is more durable
B. Paper money is more valuable
C. Paper money is easier to transport
D. Paper money is less prone to counterfeiting
Answer: C. Paper money is easier to transport
17. Which of the following is not a characteristic of money?
a) Durability
b) Portability
c) Uniformity
d) Scarcity
Answer: d) Scarcity
18. What is the primary function of money?
Answer: To serve as a medium of exchange.
19. Which of the following is not a form of money?
a) Credit cards
b) Gold coins
c) Barter system
d) Stocks
Answer: c) Barter system
20. What is the term used to describe the value of money in terms of goods and
services it can buy?
Answer: Purchasing power
21. Which of the following is not a function of money?
a) Store of value
b) Unit of account
c) Measure of inflation
d) Standard of deferred payment
Answer: c) Measure of inflation
22. What is the term used to describe the ease with which money can be
converted into other forms of assets or goods?
Answer: Liquidity
23. Which of the following is not a feature of fiat money?
a) Backed by gold or silver
b) Legal tender
c) Not redeemable
d) Government-issued
Answer: a) Backed by gold or silver
24. Which of the following is not a benefit of using money?
a) Increased efficiency in transactions
b) Standardization of value
c) Elimination of barter system
d) Increased inflation
Answer: d) Increased inflation
25. What is metallic money?
A. Money made of metal
B. Money backed by metal
C. Money that is easily divisible
D. Money that is accepted worldwide
Answer: A
26. Which of the following is NOT a type of metallic money?
A. Gold coins
B. Silver bars
C. Copper notes
D. Bronze coins
Answer: C
27. Which of the following is NOT a characteristic of metallic money?
A. Durability
B. Divisibility
C. Indestructibility
D. Portability
Answer: C
28. Which of the following is a benefit of using metallic money?
A. It is easily counterfeited
B. It is easily damaged
C. It is easily transported
D. It is easily inflated
Answer: C
29. Which of the following is NOT a feature of good metallic money?
A. Acceptability
B. Scarcity
C. Durability
D. High inflation rate
Answer: D
30. Which of the following is a benefit of using precious metals as money?
A. They are easily counterfeited
B. They are easily inflated
C. They have intrinsic value
D. They are easily transported
Answer: C
31. Which of the following is NOT a reason why metallic money is no longer
widely used?
A. It is easily counterfeited
B. It is easily damaged
C. It is bulky
D. It is easily transportable
Answer: D
32. What is a gold standard?
A. A monetary system in which the unit of currency is backed by gold
B. A monetary system in which the unit of currency is backed by silver
C. A monetary system in which the unit of currency is backed by copper
D. A monetary system in which the unit of currency is backed by paper
Answer: A
33. Which country was the first to adopt a gold standard?
A. France
B. England
C. United States
D. Germany
Answer: A
34. Which of the following is NOT a benefit of a gold standard?
A. Stability of prices
B. Protection against inflation
C. Facilitation of international trade
D. Ability to print unlimited amounts of money
Answer: D
35. Which of the following is a disadvantage of a gold standard?
A. Inflexibility in times of crisis
B. Inability to print money
C. Lack of control over the money supply
D. All of the above
Answer: D
36. Which of the following is NOT a reason why countries abandoned the gold
standard?
A. Inability to print money
B. Inflexibility in times of crisis
C. Lack of control over the money supply
D. Ability to print unlimited amounts of money
Answer: D
37. Which of the following is a benefit of a gold standard for investors?
A. Protection against inflation
B. Stability of prices
C. Predictability of the value of money
D. All of the above
Answer: D
38. What is paper money?
A. Money made of paper
B. Money made of precious metals
C. Money made of plastic
D. Money made of cloth
Answer: A. Money made of paper
39. Which country issued the first paper money?
A. China
B. India
C. United States
D. Germany
Answer: A. China
40. Who is responsible for issuing paper money in the United States?
A. The Federal Reserve System
B. The United States Treasury Department
C. The Internal Revenue Service
D. The Securities and Exchange Commission
Answer: A. The Federal Reserve System
41. What is the purpose of paper money?
A. To act as a store of value
B. To facilitate transactions
C. To track economic growth
D. To provide employment opportunities
Answer: B. To facilitate transactions
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1st Unit Complete