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Managerial Economics

SUPPLY OF MONEY
Definition of Supply Of Money

 “Money Supply refers to the amount of money
which is in circulation in an economy at
any given time. It is the total stock of
money held by the people consisting of
individuals, firms, State and its
constituent bodies except the State
treasury, Central Bank and Commercial
banks.”
§ Money held by people on a given day.
§
§ Money supply viewed overtime is viewed as a
flow.
§
§ Money supply plays a crucial role in
determination of price level and interest
rate.
§
§ In economic analysis it is presumed that Money
supply is the policy of Central Bank and
Commercial Banks.
§
§ Supply viewed from point of stock is money
Three participants involved in
determination of Money Supply
§ The Central Bank, which determines the monetary
base, the reserve requirements and sets the
discount rate at which it lends to Commercial
Banks.
§
§ The public, which determines its currency holdings
relative to its demand deposits.
§ The Commercial Banks, which for a given required
reserve ratio, determine their actual holdings
of reserves as against their demand deposits
liabilities.
 Growth of money supply is an important factor not
only for acceleration of economic development
but also to achieve price stability.

 But it should be controlled.

 Kept within proper limits, it can accelerate
economic growth but exceeding of the limits will
retard it.

 Thus its management is essential.
IMPORTANCE OF MONEY SUPPLY

• Acceleration of process of economic development

• To achieve price stability

• There should not be inflation or deflation

• It solves the problem of inadequacy

• It affect the rate of economic growth
CONCEPT OF MONEY SUPPLY


• Currency with the
public


• Demand deposits with
the public


CURRENCY WITH THE PUBLIC

• Currency notes in circulation are issued by
the RBI


• The number of rupee notes & coins in
circulation


• Small coins in circulation
DEMAND DEPOSITS WITH THE PUBLIC

 Banking system has developed in developed countries
& not sufficiently in developing countries.
Constituents Of Money Supply

Traditional Modern
Approach Approach
TRADITIONAL APPROACH
§ The money supply consist of coins & notes and bank
money consist of checkable demand deposit with
commercial bank.

§
§ Central bank has monopoly of note issue and supply
of money depends upon it.
§
§ India adopted the Minimum Reserve System in 1957
under this RBI has to maintain a minimum reserve
of Rs.200 cr. consisting of gold & foreign
securities.
§
TRADITIONAL APPROACH

• RBI has the power to issue unlimited amount of
currency in country.

• Bank money is considered as secondary money where
as cash money is known as high powered supply.

• Thus, the total supply of money is the sum of high
powered money and secondary money.
MODERN APPROACH

 According to modern approach money supply
includes coins, currency, notes, deposit
of commercial banks, financial asset,
treasury bills, bonds, equities.
Ajay Shelar

3049
SOURCES OF MONEY SUPPLY

The sources of supply of money in
India are:
§
§Reserve Bank Of India

§
§Commercial Bank
§
RESERVE BANK OF INDIA

§RBI is the main source of money supply in our
country.
§
§
§Money supply by RBI is known as “ high power
money ”.
§
§
§RBI issues currency on the basis of minimum
reserve system.
§
§
RESERVE BANK OF INDIA
In India there are two sources of
“High power money supply ”.
§
1. Reserve Bank Of India,
2. Government Of India.
§
§
The currency issued by RBI on behalf of the
government accounts for only 7-8% of the
total high power money.
§
§
§
COMMERCIAL BANKS

§The money that commercial banks supply
is
called as “ credit money ”.
§
§
§It is the outcome of their business
transaction.
§
§
§The money deposited in the banks are
called as “primary deposits”.
USES OF MONEY SUPPLY
§It is the central point of all economic
activities.
§

§Money serves as a medium of exchange.
§

§The demand for money is made to facilitate the
trading activities.
§
v
§A lack of synchronization between money inflows &
outflows both for individuals & business firms
compel them to help money in cash for meeting day
to day requirements.
FACTORS AFFECTING MONEY SUPPLY

a. Velocity of money
b.
c. Volume of trade
d.
e. Banking habits
FACTORS AFFECTING MONEY SUPPLY

d. Size of monetary base
e.
f. Cash reserve ratio
g.
h. Monetary policy of Central bank
i.
Sneha Samjiskar

3043
VELOCITY OF CIRCULATION OF
MONEY
“The velocity of circulation of money refers to
the average number of times a unit of money as a medium
of exchange changes hands during a given year.”

The supply of money in a given period is
obtained by multiplying the money in circulation with
the coefficient of velocity of circulation i.e.

M×V
M=Total amount of money in circulation
V=Velocity of circulation of money in the given period.
FACTORS DETERMINING VELOCITY OF
CIRCULATION OF MONEY

1. Time unit of income receipts
2.
3. Method & habits of payment
4.
5. Regularity of income receipts
6.
7. Saving habits of the people
8.
FACTORS DETERMINING VELOCITY OF
CIRCULATION OF MONEY

5. Income distribution
6.
7. Development of banking & financial
system
8.
9. Business cycle
10.
11.Liquidity preference of the people
12.
13.Speedy clearance of checks &
transfer of funds
Ideal Supply of Money
 What is ideal supply of money..?

Relationship of ideal money

a. with Inflation
b. with Depression
 Ideal supply of money is one at which
supply of money multiplied by its
velocity=demand for money
Money Supply in India

 Measures of money supply
 M1
 M2
 M3
 M4

Practical view
Assumption

• There is a single bank (monopoly bank)
• The bank accepts only demand deposits
• The banks CRR requirement is 20%
• And excess reserve requirement is 12%
• The banks holds its assets only in
the form of cash reserves and loans
& advances.
Money creation leads to money supply

LABLITIES Rs . ASSETS Rs .

Cash Reserve
A ‘s deposit 100.00 Ratio(CRR) 20.00

Excess reserves 80.00

Total 100.00 Total 100.00
LABLITI Rs . ASSETS Rs.
ES

A ‘s 100.00 CRR(20+16) 36.00
deposit
B’s 80.00 Loan to B 80.00
deposit
Excess cash 64.00
reserves
TOTAL 180.00 Total 180.00
LABLITIES Rs . ASSETS Rs .

A ‘s deposit 100.00 CRR(20+16+……)100.00

B’s deposit 80.00 Loan to B 80.00

…………. ……. ……………. …….

Net deposit 00.00 Excess cash 00.00
reserve
TOTAL 500.00 Total 500.00
How RBI measures Money supply

 M1 = C + DD + OD

 where,
 C = Currency held by the public
 DD = Net demand deposits
with the bank
 OD = Other deposits with RBI
The estimate of money stock ( m3 ) in India as
on 31 st March 2004
Items Money Rs. In cr.
Supply % Share
Stock of money 2000349 100.00
(a+b+c+d)
Currency with public 316758 15.83
Demand deposit with bank 251371 12.57
Time deposit with public

Other deposit with R.B.I 1427179 71.37
 5041 0.25

Reserve money(a+b+c)
(Reserve Money as % of 436429 100.00
stock of money=21.82%)
Currency in circulation

Bankers deposit with the 327023 74.93
R.B.I 104365 23.91
Other deposit with R.B.I

5041 1.16
Case study

§ Reserve money (M0)
§
§ Narrow money (M1)

§ Broad money (M3)
§
Case study

Money multiplier

Monetization of economy
Does money have future..?

• RBI ’ s control has been loosened.

• Supply of money is affected.