Section A: Key terms and recall
Define money. [2 marks]
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Money is anything that is generally accepted as a means of payment for goods and services and the repayment of debts. It has three main functions: medium of exchange, store of value, and unit of account. [2 marks]
List the three main functions of money. [3 marks]
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The three main functions of money are: 1. Medium of exchange 2. Store of value 3. Unit of account [1 mark each]
What is the difference between narrow money and broad money? [2 marks]
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Narrow money refers to the most liquid forms of money, such as coins and notes in circulation, while broad money includes narrow money plus other less liquid forms of money, such as savings deposits and time deposits. [1 mark each]
Name two types of banks. [2 marks]
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Two types of banks are: 1. Commercial banks 2. Central banks [1 mark each]
What is the primary function of a central bank? [2 marks]
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The primary function of a central bank is to control the money supply and influence monetary policy to achieve macroeconomic objectives such as price stability, full employment, and economic growth. [2 marks]
Section B: Applying your knowledge
Imagine you are planning a trip to the cinema with friends. How might you use money as a medium of exchange in this scenario? [2 marks]
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You might use money as a medium of exchange by paying for cinema tickets, snacks, and drinks using coins or notes, or by transferring money electronically using a mobile app or debit card. [2 marks]
Explain how a commercial bank creates money when it grants a loan. [3 marks]
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When a commercial bank grants a loan, it creates new money by crediting the borrower's account with the loan amount. This new money enters the economy and can be used for transactions, increasing the money supply. The bank also earns interest on the loan, which contributes to its profits. [3 marks]
Why might a central bank decide to increase the money supply? [3 marks]
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A central bank might decide to increase the money supply to stimulate economic growth, reduce unemployment, or achieve a specific inflation target. By increasing the money supply, the central bank can lower interest rates, encourage borrowing and spending, and boost aggregate demand. [3 marks]
Describe a situation where the store of value function of money might be limited. [2 marks]
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The store of value function of money might be limited during periods of high inflation, when the purchasing power of money decreases over time. In such situations, people may prefer to hold assets such as property, gold, or foreign currency, which are expected to appreciate in value. [2 marks]
Section C: Explain and analyse
Explain the relationship between money, interest rates, and inflation. [6 marks]
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Money, interest rates, and inflation are closely related. The central bank can influence the money supply and interest rates to control inflation. When the money supply increases, interest rates tend to fall, encouraging borrowing and spending, which can lead to higher inflation. Conversely, when the money supply decreases, interest rates tend to rise, discouraging borrowing and spending, which can lead to lower inflation. The central bank must carefully balance these factors to achieve its macroeconomic objectives. [6 marks]
Analyse the potential consequences of a bank run on a commercial bank. [5 marks]
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A bank run occurs when a large number of depositors withdraw their funds from a bank simultaneously, often due to a loss of confidence in the bank's solvency. The potential consequences of a bank run include: 1. Liquidity problems: The bank may struggle to meet withdrawal demands, leading to a shortage of cash. 2. Insolvency: If the bank cannot meet its obligations, it may become insolvent and collapse. 3. Contagion: A bank run can spread to other banks, leading to a loss of confidence in the entire banking system. 4. Economic instability: A bank run can lead to a reduction in lending, a decrease in aggregate demand, and a recession. 5. Government intervention: The government may need to intervene to protect depositors and maintain financial stability, for example, by providing a guarantee on deposits or nationalising the bank. [5 marks]
Section D: Challenge
Investigate the role of cryptocurrencies, such as Bitcoin, as a form of money. Do they fulfil the three main functions of money? Justify your answer. [6 marks]
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Cryptocurrencies like Bitcoin have gained popularity in recent years as a form of digital money. To determine whether they fulfil the three main functions of money, we can analyse their characteristics: 1. Medium of exchange: Cryptocurrencies can be used to buy goods and services, although their acceptance is still limited compared to traditional forms of money. 2. Store of value: Cryptocurrencies can be stored and used for future transactions. However, their value can be highly volatile, making them a risky store of value. 3. Unit of account: Cryptocurrencies are not commonly used as a unit of account, as prices are typically denominated in traditional currencies such as US dollars or euros. In conclusion, while cryptocurrencies may fulfil some of the functions of money, their limited acceptance, volatility, and lack of use as a unit of account mean that they are not yet a widely accepted form of money. [6 marks]