Notes in Economics-2

Money Banking and Stock Market

1.       Money is a standard unit of measurement for economic Magnitudes

2.       It also represent cash balance that a household has. The reason that cash balances are required serve three purposes: transaction, precautionary, speculative.

3.       Money is also medium of exchange and a temporary store of value.

4.       Money is defined in two ways, Narrow Money – M1 ( Currency with Public + Demand Deposits with the banks  + Other deposits with RBI) and Broad Money ( M1+ Time deposits with banks)

5.       In 2011, M1 in India was 16.3 Trillion Rupees and Broad Money was 65 Trillian Rupees.

6.       In Barter system, a person could exchange a good with another system only if the other person required that good. This matching of mutual demands for a barter exchange is called “double coincidence of wants.

7.       How Banks earn a profit

a.       They earn a profit due to three tendencies of depositers:

                                                               i.      When people deposit money in a bank, they do not withdraw their money immediately.

                                                             ii.      When they withdraw money, they do not withdraw in full

                                                            iii.      People do not withdraw money simultaneously with others.

b.      Hence bank keeps aside a portion of the initial cash deposit ( primary deposit) of an account holder and lends the remaining amount to a firm, on the condition that the firm opens an account in the bank, in which the money loaned is deposited. This creates an additional deposit- a secondary deposit with the bank, for which no new cash was actually deposited in the bank. Once again using the same three assumptions, the bank lends the remaining amount to yet another firm. Thereby bank creates deposits which are much larger than the initial deposits. This multiple creation of credit and deposit allows banks to charge interest on loans and profit.

c.       A bank may turn greedy and keep a low portion as cash. To prevent this, RBI sets a minimum limits on the cash reserve maintained by banks. This min. limit is called the Cash Reserve Ratio ( CRR) (Varies from 3 to 20 %).

d.      RBI also stipulates that bank maintain a certain amount of their deposit liabilities in the form of secure investments- government securities, gold or cash. This is called SLR ( Varies from 20-39%).

e.      In India deposit holders are ensured up to a max of Rs. 1 Lakh each in case there is a bank failure.

Adapted from Book: Day to Day Economics- By Prof. Satish Y. Deodhar ( Buy this Book)