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Lecture 2

IT 1081C Lecture Notes - Lecture 2: Barter, Open Market Operation, Commercial Bank


Department
Information Technology
Course Code
IT 1081C
Professor
Mark Stockman
Lecture
2

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CHAPTER 3 MONEY AND BANKING
CONTENTS OF THIS UNIT
3.1 Money meaning and functions
3.2 Supply of money- Currency held by the public and net demand deposits held by
commercial banks
3.3 Money creation by the commercial banks
3.4 Central bank and its functions (example of the Reserve Bank of India) Bank of issue,
Government bank, Bankers bank, Controller of credit through bank rate, CRR SLR repo
rate, reverse repo rate open market operations and margin requirement
3.1 Meaning of money
Money is that which money does.
Anything which is generally acceptable by the people in exchange of goods and services or in
repayment of debts is called money.
Barter its meaning and its drawbacks
Direct exchange of goods against goods without the use of money is called Barter exchange.
An economy based on barter exchange is called CC economy. Commodity for commodity
exchange economy. However as transactions increased inconveniences increased involving
rising trading costs. Trading costs are costs of engaging in trade. It has 2 components and they
are search cost and disutility of waiting.
Drawbacks of barter system
1.
Lack of double coincidence of wants: The simultaneous fulfillment of mutual wants by
buyers and sellers is known as double coincidence of wants. Barter system requires
double coincidence of wants. Example If A possesses a cow and wants exchange it for a
horse he has to find a person who can not only spare a horse but also wants a cow.
Therefore under barter system, exchange remained extremely limited.
It became more difficult and time consuming if goods needed by a person were many.
2 Lack of common measure of value
The barter system does not provide a common unit in which the value of all
Goods and services can be stated.
Even if a buyer and seller of each other commodity happen to meet, the problem arises
in what proportion the 2 goods are to be exchanged .
When thousands of articles are produced and exchanged then will be unlimited number
of exchange ratios create many difficulties.
Lack of common unit of value implies lack of an accounting system. Accounting also
becomes a big problem due to the absence of a common unit.

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3 Lack of standard for deferred payment:
There is a problem of borrowing and lending.
In a barter economy such payments have to be made in specific goods.
This creates problems related to quality of goods, types of goods and variations in the
value of goods over time.
It is difficult to engage in contracts which involve future payments due to lack of any
satisfactory unit
4. Lack of divisibility:
How to exchange goods of equal value? For example a shoe maker wants to exchange
his shoes for a loaf and the exchange value of a piece of loaf is fraction of a pair of
shoes.
shoes cannot be subdivided without destroying their values. Thus lack of divisibility
makes barter exchange impossible.
5.Lack of store of value
The barter system did not provide any method for storing generalized purchasing
power.
The stocks of commodities held by people were subject to appreciation or depreciation
in value.
It also involved storage costs.
In order to overcome the disadvantage of barter system money was invented by the
society.
Functions of money
Money as the medium of exchange: money came into existence to remove the
inconveniences of barter. Medium of exchange function of money is the primary
function of money. Money is also called a bearer of options or generalized
purchasing power because it provides freedom of choice to buy things he wants
most from those who offer best bargain.
Money as a store of value: It can store value of goods in liquid form. By spending it
we can get commodity in future. People prefer to keep a part of their wealth in the
form of money. This desire is known as liquidity preference. Thus it would seem that
value can be stored by hoarding money.
Money as the standard of deferred payments: Debts are usually expressed in terms
of the money of account. Loans are taken and repaid in terms of money.Money is
accepted as standard of deferred payments because
It has general acceptability, it is more durable compared to other commodities.
Money as unit of value: money serves as unit of value. Money is measuring rod.
Different goods produced in the country are measured in different units like cloth in
metres, milk in litres, etc without a common unit exchange of goods becomes
difficult. Values of all goods and services can be expressed easily in a single unit
called money. Without a measure of value there can be no pricing process. without
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