Question

Question 1

(a) Elaborate on the FOUR (4) main functions of money. [16 marks]

(b) Elaborate on the TWO (2) main components of money based on the narrowest definition of money. [14 marks]

Question 2

(a) Explain on the impact of a drop in the discount rate on the supply of money in the market. [15 marks]

(b) Based on your answer above, select an economic problem where that impact would work and explain what happens.

[15 marks]

Answer 1

Functions of money:

1) Medium of exchange: Money acts as a medium of exchange to facilitate transactions. When there was no money transaction was conducted by exchange of goods and services, called barter system. The barter system was good but one difficulty was in order to get a particular commodity one must have a good or service of equal value, which the supplier also wants. In other way, it can be described as, in barter system, transaction is possible if there is a double coincidence of wants. This problem is solved by money, it acts as a medium of exchange to make possible all types of transactions by all parties, regardless of their demand for each others' goods and services.

2) Store of value: Money must hold its value to act as a medium of exchange. Money is not unique as a store of value, there are other stores of value, such as, land and stamps. Money depreciates with inflation, so it can't be the best store of value. However, it is more acceptable because of its liquidity, which means convertibility of assets into cash. Bond and government securities are the assets form of money which can be converted into money later on. As money is the most liquid asset among all other assets, people like to store their assets in the form of money.

3) Unit of account: Money also acts as a unit of account, it serves as a common unit of the value of goods and services meant for exchange. When the value of goods and services are known in terms of money, it is easy on the part of both seller and buyer to exchange. In barter system there are many exchange rates, but money functions as one exchange rate.

4) Standard of Deferred Payments: Money acts as a standard of deferred payment, by making lending and borrowing easier. In a barter system, there are problems in lending and borrowing. Money acts as a standard of deferred payment where transactions are based on credit.

b.Two main components of money are: currency and checking accounts.

Currency: Paper money and coin are the two forms of currency issued by the government and the banks. The total supply of money is determined by banks, the Federal Reserve, the government, businessmen and the consumers. When the supply of money in circulation rises, the value of dollar decreases, which tends to price rise. When the supply of money in circulation decreases, the value of dollar increases, which tends to price fall. So there is an inverse relationship between supply of money and value of dollar.

Checking Accounts: Checking account or demand account is a deposit account in a financial institution that permits deposits and withdrawals. Checking accounts are very liquid and it can be accessed by checks, ATM machines and electronic debits. A checking account allows an user to make numerous withdrawals and unlimited deposits. It can be commercial or business accounts, student accounts and joint accounts. A commercial checking account is mostly used in business and business officers and managers are the signing authority on the account. Banks often permit to sweep the checking account if the accounts have large balances. This means withdrawing excess cash from the account and investing it in overnight interest generating funds. On the next business day, the funds and the earned interest are deposited back into the checking account.