Explain the process of money creation by the commercial banks wi

Subject

Economics

Class

CBSE Class 12

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 Multiple Choice QuestionsShort Answer Type

31.

Explain the 'redistribution of income' objective of Government budget. 

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32.

From the following data about a Government budget, find out (a) Revenue deficit, (b) Fiscal deficit and (c) Primary deficit:
                                                                                       (Rs. Arab)
(i) Capital receipts net of borrowings                                       95
(ii) Revenue expenditure                                                        100
(iii) Interest payments                                                            10
(iv) Revenue receipts                                                             80
(v) Capital expenditure                                                          110

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33.

Giving reasons classify the following into intermediate products and final products:
Furniture purchased by a school.

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34.

Giving reasons classify the following into intermediate products and final products:
Chalks, dusters, etc. purchased by a school. 

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35.

Explain the role of the following in correcting 'deficient demand' in an economy: 
Open market operations.

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36.

Explain the role of the following in correcting 'deficient demand' in an economy: 
Bank rate

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37.

Explain the role of the following in correcting 'excess demand' in an economy: 
Bank rate

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38.

Explain the role of the following in correcting 'excess demand' in an economy: 
Open market operations

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 Multiple Choice QuestionsLong Answer Type

39.

Distinguish between collusive and non-collusive oligopoly. Explain how the oligopoly firms are interdependent in taking price and output decisions.

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40.

Explain the process of money creation by the commercial banks with the help of a numerical example. 


Process of Creation of Money:
The process of money creation by the commercial banks starts as soon as people deposit money in their respective bank accounts. After receiving the deposits, as per the central bank guidelines, the commercial banks maintain a portion of total deposits in form of cash reserves. The remaining portion left after maintaining cash reserves of the total deposits is then lend by the commercial bank to the general public in form of credit, loans and advances. Now assuming that all transactions in the economy are routed through the commercial banks, then the money borrowed by the borrowers again comes back to the banks in form of deposits. The commercial banks again keep a portion of the deposits as reserves and lend the rest. The deposit of money by the people in the banks and the subsequent lending of loans by the commercial banks is a never-ending process. It is due to this continuous process that the commercial banks are able to create credit money a multiple time of the initial deposits.
The process of creation of money is explained with the help of the following numerical example.

Rounds Deposits Received  Loans Extended Cash Reserves
Initial 10,000 8,000 2,000
Ist Round 8,000 6,400 1,600
IInd Round 6400 5,120 1,280
- - - -
nth Round - - -
Total 50,000 40,000 10,000

Suppose, initially the public deposited Rs 10,000 with the banks. Assuming the Legal Reserve Ratio to be 20%, the banks keep Rs 2,000 as minimum cash reserves and lend the balance amount of Rs 8,000 (Rs 10,000 – Rs 2,000) in form of loans and advances to the general public.
Now, if all the transactions taking place in the economy are routed only through banks then, the money borrowed by the borrowers is again routed back to the banks in form of deposits. Hence, in the second round there is an increment in the deposits with the banks by Rs 8,000 and the total deposits with the banks now rises to Rs 18,000 (that is, Rs 10,000 + Rs 8,000). Now, out of the new deposits of Rs 8,000, the banks will keep 20% as reserves (that is, Rs 1600) and lend the remaining amount (that is, Rs 6,400). Again, this money will come back to the bank and in the third round, the total deposits rises to Rs 24,400 (i.e. Rs 18,000 + Rs 6,400).
The same process continues and with each round the total deposits with the banks increases. However; in every subsequent round the cash reserves diminishes. The process comes to an end when the total cash reserves (aggregate of cash reserves from the subsequent rounds) become equal to the initial deposits of Rs 10,000 that were initially held by the banks. As per the above schedule, with the initial deposits of Rs 10,000, the commercial banks have created money of Rs 50,000.

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