Chapter 3 money and credit- economics class 10th

Introduction

Money plays a central role in economic activities. It serves as a medium of exchange and simplifies trade by eliminating the complexities of barter. In this chapter, we explore the evolution of money, different forms of money, and the role of credit in economic development. We also dive into formal and informal sources of credit, their benefits and drawbacks, and the significance of financial inclusion.

Key Terms

Barter System: An exchange of goods and services without using money.
Double Coincidence of Wants: A condition where two parties each desire the goods or services that the other provides.
Currency: Paper notes and coins issued by the government.
Cheque: A written order directing a bank to pay money.
Collateral: Asset pledged by the borrower to obtain a loan.
Formal Sector Loans: Loans given by banks and cooperatives, regulated by the government.
Informal Sector Loans: Loans provided by moneylenders, traders, or relatives, not regulated by the government.

1. The Role of Money

Money eliminates the complexities of the barter system, where finding two people with matching needs—called double coincidence of wants—was difficult. Money facilitates trade by acting as a universally accepted medium of exchange. It has following features:

The features of money are:

Medium of Exchange: Money facilitates the exchange of goods and services, eliminating the need for a barter system where a double coincidence of wants is required.
Unit of Account: Money provides a common measure to value goods and services, allowing them to be compared in terms of price.
Store of Value: Money can be saved and stored for future use without losing value (though inflation may affect purchasing power over time).
Standard of Deferred Payment: Money is accepted for future payments, making it easier to engage in contracts and credit transactions.

Table: Comparison Between Barter System and Money as a Medium of Exchange

Aspect	Barter System	Money as a Medium of Exchange
Double Coincidence of Wants	Necessary	Not Necessary
Efficiency in Trade	Time-consuming	Quick and Efficient
Standard of Value	No uniform standard	Universal Standard (Currency)
Flexibility	Limited	Highly Flexible

1.1 Evolution of Money

Barter System: Before money, people used the barter system, where goods were exchanged for goods. However, this system had limitations:
- Double Coincidence of Wants: Both parties needed to want what the other had.
- Difficulty in Valuation: It was hard to agree on how much of one good was equivalent to another.

1.2 Emergence of Money

Money evolved to solve the problems of barter. It acts as a universally accepted medium of exchange, a store of value, and a unit of account.
Forms of Money:
- Commodity Money: Items like gold or silver that had intrinsic value.
- Paper Currency: Introduced to simplify trade and avoid the bulkiness of commodity money.
- Modern Forms: Today, we use paper notes and coins, and increasingly, digital money like credit cards, debit cards, and mobile wallets.

Type of Money	Examples
Commodity Money	Gold, Silver
Paper Currency	Rupees, Dollars
Digital Money	Credit/Debit Cards, UPI, e-Wallets

2. Modern Forms of Money

2.1 Currency

Notes and Coins are recognized as legal tender by the government.
In India, the Reserve Bank of India (RBI) issues currency except for one-rupee notes, which are issued by the Ministry of Finance.

2.2 Deposits with Banks

People deposit their earnings in banks, which are used for withdrawal via checks or digitally. This is considered money in its modern form because it can be used for transactions.
Demand Deposits: These are deposits in the bank that can be withdrawn on demand, such as savings or current accounts.

2.3 Money Supply

Money Supply refers to the total stock of money available in an economy at a particular point in time. It includes currency held by the public and the money deposited in banks that can be used for transactions. The money supply is crucial for understanding inflation, interest rates, and overall economic health.

Components of Money Supply:

Currency in Circulation: This includes paper notes and coins held by the public.
Demand Deposits: These are funds that people deposit in their bank accounts and can be withdrawn anytime, such as in savings or current accounts. They are also called checking accounts.
Time Deposits: These are fixed deposits or term deposits in banks that cannot be withdrawn on demand but contribute to the overall money supply.

Measures of Money Supply:

The money supply is measured using different aggregates, represented by M1, M2, M3, etc.

M1: Consists of currency with the public, demand deposits, and other liquid instruments.
M2: Includes M1 plus savings deposits in post offices and banks.
M3: Includes M1 plus time deposits (fixed deposits) in banks.

The central bank of a country (e.g., the Reserve Bank of India) regulates and controls the money supply to manage inflation and promote economic stability.

Measure	Components	Explanation
M0 (Reserve Money or Base Money)	1. Currency in circulation (notes and coins with the public) 2. Cash reserves with banks 3. Deposits of commercial banks with the central bank	– It is the most liquid form of money. – Also called “High Powered Money” because the central bank can influence the overall money supply through this.
M1 (Narrow Money)	1. Currency with the public 2. Demand deposits with commercial banks (savings and current accounts) 3. Other deposits with the RBI	– M1 is the most liquid part of the money supply. – It represents the money readily available for transactions.
M2	1. M1 2. Savings deposits with post office savings banks	– M2 is M1 plus savings deposits in post offices. – Slightly broader than M1 but still quite liquid.
M3 (Broad Money)	1. M1 2. Time deposits with commercial banks (fixed deposits)	– M3 is also called “Broad Money”. – It is less liquid than M1 but includes a larger volume of money supply.
M4	1. M3 2. Total deposits with post office savings banks (excluding National Savings Certificates)	– M4 includes the broadest definition of the money supply, adding post office deposits to M3. – It is the least liquid among the four measures.

Summary:

M0: Base money controlled by the central bank.
M1: Money readily available for transactions (high liquidity).
M2: M1 plus post office savings (slightly broader).
M3: Broad money (M1 + time deposits, less liquid).
M4: The broadest definition, including M3 and post office deposits.

Forms of Modern Money	Description
Currency	Physical money: notes and coins
Demand Deposits	Bank deposits used for transactions
Digital Payments	Credit/Debit Cards, e-wallets, UPI

3. Loan Activities of Banks

3.1 Role of Banks

Banks accept deposits and provide loans. They play an essential role in channeling money from those with surplus funds (depositors) to those in need (borrowers).
Interest on Deposits: Banks pay interest to depositors as an incentive.
Interest on Loans: Banks charge a higher rate of interest on loans than they pay on deposits. The difference between these rates is the bank’s income.

3.2 Loans and Credit Creation

When banks lend, they create credit. The process of lending is based on the idea that not all depositors withdraw money at the same time, allowing banks to lend a portion of the deposits.

3.3 Importance of Credit in Economic Development

Credit enables people to invest in business activities, education, housing, etc., fostering economic growth.

4. Terms of Credit

4.1 Definition of Credit

Credit refers to an agreement where a lender provides money to a borrower with the expectation of future repayment along with interest.

4.2 Terms of Credit

Every loan agreement specifies conditions or terms of credit, which include:
- Interest Rate: The cost of borrowing money.
- Collateral: An asset that the borrower pledges to the lender as security.
- Documentation: Paperwork such as loan agreements and identification.
- Mode of Repayment: The schedule and method of repayment.

Term	Explanation
Interest Rate	Cost of borrowing
Collateral	Asset pledged to secure the loan
Documentation	Required paperwork and identification
Repayment Mode	Terms and schedule of repayment

5. Formal and Informal Sources of Credit

5.1 Formal Sources

Banks and Cooperatives are the primary formal sources of credit in India.
Regulation: The RBI regulates the functioning of formal lenders, ensuring transparency and security for borrowers.

5.2 Informal Sources

Moneylenders, traders, employers, and relatives fall into informal sources.
They do not follow the regulations of formal credit institutions, often charging very high-interest rates.

Formal Credit	Informal Credit
Banks, Cooperatives	Moneylenders, Traders, Friends, etc.
Lower Interest Rates	Higher Interest Rates
Regulated by RBI	Not Regulated
Require Collateral and Documents	May not require formal procedures

6. Self-Help Groups (SHGs) for the Poor

6.1 Definition and Role

SHGs are small groups of people, usually in rural areas, who come together to pool their savings and provide loans to each other.
These groups serve as informal financial institutions, offering an alternative to exploitative informal lenders.

6.2 Benefits of SHGs

SHGs help the poor access credit at low interest rates and without the need for formal documentation or collateral.
They also encourage savings and provide members with financial literacy and empowerment.

7. Credit and Financial Inclusion

7.1 Financial Inclusion

Financial inclusion aims to make financial services available to all segments of society, especially marginalized groups.
It ensures that everyone has access to formal sources of credit at affordable rates, reducing dependency on informal sources.

7.2 Government Initiatives

The government has launched initiatives like Jan Dhan Yojana, promoting bank accounts for all, and Mudra Yojana, providing loans to small businesses without collateral.

Conclusion

Money and credit are essential to the functioning of an economy. The chapter highlights the evolution of money, the critical role of banks, and the importance of credit in fostering economic development. Understanding formal and informal sources of credit and the necessity of financial inclusion helps in addressing issues of poverty and inequality.