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MODEL ANSWER
2 ND^ SEM 5YEARS B.A.L.L.B
SUB: ECONOMICS-2-MAJOR
MONEY BANKING AND INTERNATIONAL TRADE
Q.1. Define Money? Explain the functions of money?
Ans: Money has been defined differently by different economists. According
to F.A walker “Money is what money does”.
According to Robertson’ money is anything which is widely accepted in payment for goods or in discharged of other kinds of business obligations’.
Money performs many functions:
- Primary functions
- Secondary functions
- Contingent functions
- Other functions
Primary Functions:
a. A medium of exchange: - The most important function of money that, it serves as a medium of exchange. It facilitates exchange through a common medium i.e. currency. This function of money has eliminated the problem of wants which was the main difficulty under barter system. b. Measures of value: - Money serves as a common unit of value. The value of all goods & Services can be expressed in terms of money. Money has provided a common yardstick to measure the value of all commodities & services in a common unit known as price.
Secondary Functions:
a. Standard of differed payments: - Money can be used for future payments. Deferred payment refers to the future payment & contractual payments such as loans &interest payments salaries etc. b. Store of value: - Generally, people have a tendency to save certain portion of their income in the form of savings & to accumulate wealth. People save money to money to meet unforeseen contingencies.
c. Transfer of values: - With the help of money values & wealth can be transferred from one place to another. Similarly, money can be transferred easily from one place to another. So, purchasing power can be transferred.
Contingent Functions:
a. Distribution of national income: - Money facilities the distribution of national income among the four factors of production as a reward in the form of rent, wages, interest & profit. b. Basis of credit: - The modern economy is based on credit. Money economy is based on credit. Money serves as a basis of the vast structure of modern credit system. c. Liquidity & Uniformity: - Money gives liquidity to various forms of wealth. That is money is most liquid form of all the assets & assets can be converted into money.
Other Functions:
a. Helps in making decisions. b. Generation purchasing power c. Determination of solvency
Q2: What do you mean by commercial bank? Explain the functions of commercial bank?
Ans. A bank is an institution which deals in money. It accepts deposits from the public & lends the same to those who are in needs of it. It is a dealer in money and credit.
Crowther, defines a banking institution as “a dealer in debt, his own & other people”.
Functions of commercial Bank
i. Primary functions ii. Secondary functions
Primary Functions
a. Accepting deposits: - It is the most important function of commercial bank. They accept several types of deposits from the public. They are
bills of exchange means enchasing the bills of exchange the banks before the date of maturity.
Secondary functions:
a. Agency Services b. General Services
Agency Services:
Bank performs certain agency services for and on behalf of their customer.
They are:
- Remittance of fund
- Collection & payment of credit instrument
- Buying & Selling of securities.
- Collection of payments
- Making of payments
- Income tax consultancy
- Acting as trustee & executor.
General Utility Service:
- Locker facility
- Issue of traveler is cheques.
- Letter of credit
- Under writing of securities
- ATM facilities
- Credit Cash
Q.3. Explain briefly the function of central Bank?
Ans. The RBI performs all traditional development and other functions.
1. Traditional Functions: a. Monopoly of note issue: - Under section 22 of the RBI Act, the bank has the sole right to issue of currency notes of all denominations of Rs. 10, 20, 50, 100, 500 & 1000 in the country. RBI follows minimum
reserve system while issuing notes since 1956. It has to maintain reserve of gold, silver & foreign exchange against issue of currency notes. b. Banker to the Govt: -RBI act as a banker, agent & adviser to the govt. The RBI performs the same functions as the commercial banks perform to their customers, such as it receives deposits from the govt & advance loans to it when it is in need. c. Banker’s Bank: - The activities of all commercial banks are controlled & managed by the RBI. The regulation of bank may be related to their licensing, branch, expansions, liquidity of assets etc. d. Lender of last resort: - The RBI helps the commercial bank in times of their financial crisis. When commercial banks are not able to get financial assistance from any source RBI cover to their rescue. That is the commercial bank can approach the RBI for loans. e. Cleaning House: - The RBI acts as a cleaning house for transfer and settlement of mutual claims of the commercial banks. As it keeps the cash reserves of all commercial banks. It is easy to settle each other debts or transfer of funds from one bank to another.
2. Development Functions: a. Agriculture Finance: - The RBI has been extending advice & financial assistance to the co- operative credit institutions for the development of agriculture. For this purpose, it has set up an agriculture credit department. b. Industrial Finance: - The RBI provides credit facilities to both small scale & large-scale industries through state finance corporation (SFC) IFCI, IDBI, ICICI etc. It also established national industrial Credit Fund in 1964 to provide financial assistance. 3. Other Functions: Research functions & Special functions are the other functions.
The RBI collets & publishes information relating to agricultural, industrial, financial sectors of the economy, experts & imports, banking, trends in money & money and capital market, price trends etc. On the basis of this information the govt can formulate and implement its
5. Easy flow of capital: International trade develops mutual relation among the countries & facilities short term & long-term flow of capital. In fact many countries depend on foreign country in the initial stage of their economic development. 6. Promotion of completion: International trade promotes competition among the different countries. International competition brings efficiency. It becomes possible to impose quality products from other countries at reasonable prices. 7. Greater Bi-lateral co-operation: International trade develops mutual co-operation among the trading countries. The countries co-operate among themselves to resolves their different & problems through bi-lateral agreements. 8. Growth of international economic institutions: It has leaded to the growth several multilaterals like IMF, IBRD, IDA, and UNCTAD & WTD. 9. Expert promotes growth: There are many countries such as Japan, France, UK, USA & in recent year South Korea, Taiwan, Malaysia, China& many Gulf countries growth through expert. In fact their strategy is to maximize export to promote economic growth.
Q5. Explain briefly the objectives & function of WTO?
Ans. The Uruguay Round Agreement of GATT, provide for the setting up of the World Trade Organization. The WTO started function from January 1, 1995. It is a watch dog of international trade and it’s regularly examines the trade regimes of individual members.
The objectives of the WTO:
In its preamble, the agreement established the WTO lays down the following objectives of WTO.
- Its relations in the field of trade& economic endeavor shall be conducted with a view to raising standards of living, ensuring full employment, expanding the production & trade in goods & services.
- To allow for the optimal use of worlds resources in accordance with the objective of sustainable development, seeking both. a) To protect and presence the environment b) To enhance the means for doing so in a manner consistent with respective needs & concerns at different levels of economic development.
- To make positive effects designed to ensure that developing countries, especially the least developed among them, secure a shave in the growth, in international trade commensurate with needs of their economic development.
- To achieve these objectivities by entering into reciprocal & mutually advantage arrangement directly towards substantial reduction of tariffs & other barriers to trade & the elimination of discriminatory treatment in international trade relations.
- To develop an integrated more viable & durable multilateral trading system encompassing the GATT, the result of past trade liberalization efforts & all the results of the Uruguay round of multilateral trade negotiations &
- To ensure linkages between trade policies, environmental policies & sustainable development. Functions of WTO:
- It facilitates the implementation administration & operations of the objective of the agreement & of the multilateral trade agreement.
- It provides the framework for the implementation administration & co- operation of the plurilateral trade agreements relating to trade in civil craft, govt procurement trade in dairy product & bovine meat.
- It provides the forums for negotiations among its members concerning their multilateral trade relations in matters dealt with under the agreements.
- It administrates of the understanding a rules &procedures governing the settlement of disputes of the agreement.
- The WTO shall administer the trade review mechanism”
- It co-operates with the IMF & the World Bank & its affiliated agencies with a view to achieving greater coherence in global economic policy making.
- The domestic capital formation and investments of UDC’s is adversely affected on account of investment by MNC’s.
- MNC’s are responsible for creating social inequalities & also breeds discontent & unrest among the workers employed in the local industries of host countries.
- MNC’s established their venture in UPD’s and exploit cheap labour available there.
- MNC’s bring in their cultural norms of attitudes in the host country & may cause threat to the original culture of the host country in various ways.
MNC’s suppress the domestic entrepreneurship and hence small state.
Q.NO.7. Explain briefly the Loan able Funds Theory of Interest?
ANS: The expression “Loan able funds” is wider in its scope. Loan able funds are the sum of money supplied and demanded at any time in the money market. It is comprehensive and includes not only savings out of the current income but also bank credit, dishoarding and disinvestments. Likewise the demand for loan able. Funds also are wider in its content. Capital is not only demanded for investment, but also for consumption and hoarding.
According to the theory, the equilibrium interest rate is determined by the equality between demand for and supply of loan able funds. Interest rate is the price paid for the use of these loan able funds.
More details regarding demand for and supply of loan able funds are given for Proper understanding.
The supply of loan able funds is derived from four sources. They are
- Savings: savings by individuals and households constitute the important source of supply of loan able funds. They are of two types. Planned and unplanned. Planned savings are savings planned by individuals at the beginning of a period in the hope of expected income and anticipitated consumption expenditure. Unplanned is the differences between the income of the preceding period and the consumption of the present period. The level of savings depends upon the level of income.
- Dishoarding: dishoarding of idle cash balances, past savings etc may be released in to the market. Dishoarding will be greater if interest rate is high and vice versa.
- Bank credit: as manufacturers of money, banks create credit money and advance it to individual and business units. Generally speaking, higher the interest rate, higher would be the advances and vice-versa.
- Disinvestments: it is the opposite of investment. It is said to take place when the stock of existing machines is allowed to wear out without being replaced or without providing for any depreciation a particular durable asset that will be wearing down. The fund which is set aside for replacement is called as Amortization Quota.
The demand for loan able funds comes mainly from three sources. They are
1. Demand for investment : loan able funds are demanded for investment purposes. Investment may be undertaken either by individuals Business houses or companies. The investment demand depends on the productivity of capital. It is interest elastic. It varies inversely with the interest rate, lower the interest rate, higher would be the demand and vice-versa.
2. Demand for consumption : people may borrow for consumption purposes. It arises when the expenditure are greater than the income of the people. This aiso varies inversely with interest rate. Lower the interest rate, higher would be demand for loans and vice-versa.
3. Demand for hoarding: some people may like to hoard a part of their savings in cash. Hoarding implies keeping cash balances. This desire to hoard is called liquidity preference. It is important to note that some people who are hoarding cash balances are also the suppliers of loan able funds. The demand for hoarding is interest elastic. Thus the demand curve slopes downwards from left to right.
Q 8. What is inflation? Explain the cause & effects of inflation?
Ans. Inflation is a global phenomenon. It is seen in every type of economy developed & under- developed. It occurs not only in war time, but also in peace time. Inflation is defined in different ways by different writes.
3. Effect on Producers: The producers of goods benefit from inflation as they get higher prices for their finished goods. No doubts, they may have to pay higher prices for the various factors of production. 4. Effects on Farmers: Farmers gain from inflation in many ways. First, they get higher prices for their products especially for essential food stuffs. Secondly, they can hoard farms products & gain from speculative rise in prices. 5. Effect on speculators: Inflation is both advantageous& disadvantageous to the wage earners. It is disadvantageous to their as the rise in their wages is less than the rise in prices. 6. Effects on fixed income groups: Fixed income groups are hit very hard by inflation, because while their money incomes remain fixed, their real incomes fall an account of the fall in value of money.
Write Short notes on:
A. Comparative Cost Theory: David Ricardo analyzed the cause for & the benefits of International trade in comparative costs. David Ricardo agreed with the analysis of Adam Smith that international trade would be mutually advantageous if one country has absolute advantage over another country in one commodity & the other country in one country has an absolute over the first country in another commodity.
He went further & pointed out that any two countries could very well gain by trading even if one of the countries is having an absolute advantage in both the products over the other country, provided the extent of absolute advantage is different in the two commodities in question, i.e. the comparative advantage is greater in respect of the other commodity in the given example, the opportunity cost of product x & product y in country A & country B with be as follows.
Country A Country B Product X 5/10= 0.5 20/15= 1.
Product y 10/2=2 15/20=0.
From the opportunity cost of the product, it is clear that country. A has comparative advantage in producing product x & country B has comparative
advantage in producing product y. So, country A can specialize in the production of product x & can gain from trading.
B. Supply of money:
Money supply refers to the total stocks of money of various kinds in existence at any particular point of time. There are two important points about money supply. They are
- Money supply is a stock concept i.e. it is the stock of money and
- It is the stock of money with the public
Since April 1977, RBI has adopted four concepts of money supply i.e.M1, M2 ,M 3 & M4.
- M 1 =It includes currency with public demand deposits & other deposits with RBI. It is turned as narrow money. It is measured as follows M 1 = C+DD+OD Where, C= Represents currency with public DD= Represent demand deposits with commercial banks. OD=Represent other deposits with RBI
- M 2 =It includes all components of M 1 and savings deposits with post office. It is measured as follows M 2 = M 1 +POSBD
Where,
M 2 = Saving Deposits M 1 = is C+DD+OD POSBD= Represent post office savings deposits.
- M 3 = It includes all the components of M 1 along with time deposits of all banks. It is a broad money concept. It is measured as follows M 3 = M 1 +TD
Where, TD = Represents Time deposits with all banks.
- M 4 = It includes all the components of M 3 and total deposits with post office savings deposits (excluding National savings certificates). It is measured as follows
Total Rs
Loan to MrYRs Total Rs. 900
This loan of Rs 810 is deposited by Mr. ‘Y’ in bank ‘C’, bank ‘C’ keeps 10% as Rs 81 of Rs 810 as cash reserves & lends Rs 729 to Mr. ‘Z’. Then the balance sheet of bank ‘C’ is as follows:
Balance Sheet of Bank ‘C’ Liabilities Assets Deposits - Rs
Total Rs
Cash Reserve Rs Loan to Mr X Rs Total Rs. 810
Thus, the process will continue till the cash deposit of Rs 1000 is completely used. The cash deposit of Rs 1000 is completely used. The cash deposit of Rs 1000 led to a loan deposits of Rs 900+800+729 & so on. Now the total deposits of all the banks shall be Rs 10,000.
Multiple Credit Creation ‘Amount in Rs’ Bank Liabilities Cash Reserve New Loan Bank A Bank B Bank C All other Banks Total for whole banking System
D) The Monetary policy of RBI.
Ans. The method adopted by the RBI to regulate and control money circulation or supply of money circulation or supply of money in the country is known as Monetary policy of RBI. It is grouped under two heads:
a. Quantitative Methods b. Qualitative Methods
Quantitative Methods:
1. Bank Rate: It is the rate of interest charged by the RBI for providing funds or loans to the banking system. This is also known as the discount rate. Banking System. This is also known as the discount rate. Banking system includes commercial & co-operative banks, Industrial Development Bank of India (IDBI) industrial Finance Corporation etc. are approved financial institutions. 2. Open Market Operations: It is an instrument of monetary policy which involves buying and selling of govt securities in open market. 3. Cash Reserve Ratio: It is a certain percentage of bank deposits which commercial bank deposits which commercial banks are required to keep with the RBI in the form of reserve or balance. 4. Statutory Liquidity Ratio: In additional to CRR, the RBI direct to commercial bank has to maintain a certain percentage of their total demand & time deposits with themselves in the form of liquid assets. Qualitative Methods:
- Margin requirement : Loans are granted by commercial bank against the securities. The amount lent by the banks is a fraction of the market value of the security. They may give loan of Rs 8000/- against a security worth of Rs 10,000/- and keep a margin of Rs 2000/-i.e.2o%. The difference between the market value of securities and the amount lent against these securities is called margin.
- Control through directives : The central bank may enforce the written or oral directives in desired direction to the commercial banks. The RBI may ask commercial banks to be rigid or liberal in granting loans.
- Moral suasion : This method of credit control involves the techniques and request made by the central bank to commercial bank to co operate with the implementation of its credit policies.
- Direct Action : It refers to the forced measures taken by the central bank against commercial banks. It may refuse to rediscount bills or advances loans against securities. It may even charge the panel rate of interest for money borrowed beyond the prescribed limit. E] The Liquidity and Profitability process of commercial bank.
Invest by branches of foreign companies, investment by subsidiaries of foreign companies and investment by other foreign controlled companies.
Foreign capital combined with skill and enterprise is essential for the development of under developed countries in several ways. They are
- It is necessary to invite foreign capital when domestic capital is inadequate for the purpose of economic growth.
- It supplements domestic savings and harness them to secure a rapid rate of growth.
3 .It provides technological expertise and helps in building a modern industrial structure.
- It paves the way for the investment of domestic capital in to new desirable channels.
- It provides valuable foreign exchange.
- It eases pressures on the balances of payments
- It can help developing countries in breaking the vicious circle of poverty.
- During the early stages of economic development of backward countries, the vary natural resources would be exploited quickly with foreign capital.
- Foreign capital helping to import some of the essential goods of consumption can help contain inflationary pressure in the economy making the process of development relatively easy and smooth.
- Foreign capital reduces the strain of development on the people of developing countries.
G]. TRIMS – Agreement on Trade Related Aspects Of Investment- Measures. It is one of the treaties conducted under WTO. It calls for the removal of all trade related investments measure within a period of five years. These measures are confined to quantititative restrictions and national treatment. In particular they relate to such measures as investment in identified areas, level of foreign investment for treating foreign companies at par with national companies, export obligations and use of local raw materials. It prevents the imposition of any performance clauses on foreign investors in respect of
earning of foreign exchange, foreign equity participation, and transfer of technology. It requires foreign investment companies to be treated at par with national companies it prevents the imposition of restriction on area of investment. It requires free import of raw materials, components and intermediates.
The agreement recognizes that certain investment measures restrict and distort tread therefore it requires madetary notification of all non conforming TRIMS and their removal within seven years for least developed countries, five years for developing countries and two years for developed countries. It establishes a committee on TRIMS which will monitor the implementation of these commitments and report to the council of trade in goods annually.
H] TRIPS – Agreement on Trade – Related Aspects of Intellectual Property Rights.
The TRIPS agreement covers seven categories of intellectual properties they are copy right and related rights, trade marks, geographical indications, industrial designs, patens, integrated circuits and tread secrets.
1. Copyrights and related rights : the parties are required to comply with Berne convention for the protection of literary and artistic work. Computer programs are included in literary works. Authors of computer program, performs on phonogram, producers of phonogram and broadcasting organization are to be given the right to authorized or prohibit the commercial rental of their works to the public. A similar exclusive right applies to films. The protection for performers and producers of sound recording are to be for no less than fifty years and for broadcasting organization for at least twenty years. 2. Trademarks : any sign or any combination of signs, capable of distinguishing the goods or services of one undertaking from those of other undertakings constitutes a trademark. Such signs, in particular words including personal names, letters, numerals, figurative elements and combinations of colours as well as combinations of such signs are eligible for registration as trademarks. The owner of the trademark has the exclusive right to prevent all third parties not having the owner’s consent from using in course of trade identical or similar for signs for goods and services.
