Managerial Economics

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Managerial Economics

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SUPPLY OF MONEYIntroduction of Money supply:-Money supply refers to the amount of money which is in circulation in an economy at any given time. It is the total stock of money held by the people, which consist of individuals, firms, State and its constituent bodies except the State treasury, Central bank and Commercial banks.Further, money supply refers to the disposable stock of money. It is the stock of money in circulation. Money supply can be viewed from two points of views, namely money supply as a stock or money supply as a flow.Money supply plays a crucial role in the determination of price level and interest rate. In economics, it is generally presumed money supply is determined by the policy of the Central bank of the country and the government. However this is not fully correct, as in the determination of money supply besides the Central bank and the government, the public and the commercial banks also play an important role.The three major participants involved in the determination of money supply are:1. Central bank, which determines the monetary base, the reserve requirements, and sets the discount rate at which it lends to commercial banks. The money issued by the Central bank is called the monetary base. For e.g. the Reserve Bank of India, which is the Central bank of India as it is called the bankers bank it decides the discount rate at which it lends to commercial banks.2. The public, which determines its currency holdings relative to its demand deposits. Explanation, the relative amount of cash and demand deposits held by the people also influence the supply of money. If people prefer to make check payments much more than cash payments, the total money supply maintained by a given monetary base would be larger and vice- versa.3. The commercial banks, which for a given required reserve ratio, determine their actual holdings of reserves as against their demand deposit liabilities. Growth of money supply is an important factor not only for acceleration of the process of economic development but, also for the achievement of price stability in the economy, however there must be controlled expansion of money supply if the objective of development with stability is to be achieved, because increase in money supply affects vitally the rate of economic growth. In fact, it is now regarded as a legal instrument of economic growth. Kept within proper limits it can accelerate economic growth but exceeding of the limits will retard it. Thus management of money supply is essential in the interest of steady economic growth.The concept of Money Supply:-By money supply we mean the total stock of monetary media of exchange available to a society for use in connection with the economic activity of the country. According to the standard concept of money supply, it is composed of the following two elements:-1. Currency with the public2. Demand deposits with the publicBefore explaining these two components of money supply, two things must be noted with regard to the money supply in the economy. First, the money supply refers to the sum of money available to the public in the economy at a point of time. Secondly, money supply always refers to the amount of money held by the public. In the term public included household, firms & institution other than banks & government.1. CURRENCY WITH THE PUBLIC: –In order to arrive at the total Currency with the public in India we add the following items1. Currency notes in circulation issued by RBI.2. The number of rupee notes & coins in circulation.3. Small coins in circulation.It is worth noting that cash reserves with the banks have to be deducted from the value of the above three items of currency in order to arrive the total currency with the public. This is because cash reserves with the banks must remain with them & cannot ther

Transcript of Managerial Economics

Page 1: Managerial Economics

Managerial Economics

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SUPPLY OF MONEY

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Definition of Supply Of Money

“Money Supply refers to the amount of money which is in circulation in an economy at any

given time. It is the total stock of money held by the people consisting of individuals, firms, State and its constituent bodies except the

State treasury, Central Bank and Commercial banks.”

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Money held by people on a given day.

Money supply viewed overtime is viewed as a flow.

Money supply plays a crucial role in determination of price level and interest rate.

In economic analysis it is presumed that Money supply is the policy of Central Bank and

Commercial Banks.

Supply viewed from point of stock is money

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Three participants involved in determination of Money Supply

The Central Bank, which determines the monetary base, the reserve requirements and

sets the discount rate at which it lends to Commercial Banks.

The public, which determines its currency holdings relative to its demand deposits.

The Commercial Banks, which for a given required reserve ratio, determine their actual holdings of reserves as against their demand

deposits liabilities.

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• Growth of money supply is an important factor not only for acceleration of economic

development but also to achieve price stability.

• But it should be controlled.

• Kept within proper limits, it can accelerate economic growth but exceeding of the limits will

retard it.

• Thus its management is essential.

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IMPORTANCE OF MONEY SUPPLY

• Acceleration of process of economic development

• To achieve price stability

• There should not be inflation or deflation

• It solves the problem of inadequacy

• It affect the rate of economic growth

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CONCEPT OF MONEY SUPPLY

• Currency with the public

• Demand deposits with the public

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CURRENCY WITH THE PUBLIC

• Currency notes in circulation are issued by the RBI

• The number of rupee notes & coins in circulation

• Small coins in circulation

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DEMAND DEPOSITS WITH THE PUBLIC

Banking system has developed in developed countries & not sufficiently in developing

countries.

Two Types of deposits

Demand deposit Time deposit

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Constituents Of Money Supply

TraditionalApproach

Modern Approach

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TRADITIONAL APPROACH

The money supply consist of coins & notes and bank money consist of checkable demand deposit

with commercial bank.

Central bank has monopoly of note issue and supply of money depends upon it.

India adopted the Minimum Reserve System in 1957 under this RBI has to maintain a minimum reserve of Rs.200 cr. consisting of gold & foreign

securities.

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• RBI has the power to issue unlimited amount of currency in country.

• Bank money is considered as secondary money where as cash money is known as high powered

supply.

• Thus, the total supply of money is the sum of high powered money and secondary money.

TRADITIONAL APPROACH

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MODERN APPROACH

According to modern approach money supply includes coins, currency, notes, deposit of commercial

banks, financial asset, treasury bills, bonds, equities.

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Ajay Shelar

3049

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SOURCES OF MONEY SUPPLY

The sources of supply of money in India are:

Reserve Bank Of India

Commercial Bank

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RESERVE BANK OF INDIA

RBI is the main source of money supply in our country.

Money supply by RBI is known as “high power money”.

RBI issues currency on the basis of minimum reserve system.

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In India there are two sources of “High power money supply”.

1. Reserve Bank Of India,

2. Government Of India.

The currency issued by RBI on behalf of the government accounts for only 7-8% of the

total high power money.

RESERVE BANK OF INDIA

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COMMERCIAL BANKS

The money that commercial banks supply is

called as “credit money”.

It is the outcome of their business transaction.

The money deposited in the banks are called as “primary deposits”.

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USES OF MONEY SUPPLY It is the central point of all economic activities.

Money serves as a medium of exchange.

The demand for money is made to facilitate the trading activities.

A lack of synchronization between money inflows & outflows both for individuals & business firms compel them to help money in cash for meeting

day to day requirements.

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FACTORS AFFECTING MONEY SUPPLY

a. Velocity of money

b. Volume of trade

c. Banking habits

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d. Size of monetary base

e. Cash reserve ratio

f. Monetary policy of Central bank

FACTORS AFFECTING MONEY SUPPLY

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Sneha Samjiskar

3043

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VELOCITY OF CIRCULATION OF MONEY

“The velocity of circulation of money refers to the average number of times a unit of money as a medium of exchange changes hands during a given year.”

The supply of money in a given period is obtained by multiplying the money in circulation with the coefficient of velocity of circulation i.e.

M=Total amount of money in circulationV=Velocity of circulation of money in the given period.

M × V

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FACTORS DETERMINING VELOCITY OF CIRCULATION OF MONEY

1.Time unit of income receipts

2.Method & habits of payment

3.Regularity of income receipts

4.Saving habits of the people

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5. Income distribution

6. Development of banking & financial system

7. Business cycle

8. Liquidity preference of the people

9. Speedy clearance of checks & transfer of funds

FACTORS DETERMINING VELOCITY OF CIRCULATION OF MONEY

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Ideal Supply of MoneyWhat is ideal supply of money..?

Relationship of ideal moneya. with Inflation

b. with DepressionIdeal supply of money is one at which

supply of money multiplied by its velocity=demand for money

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Money Supply in India

Measures of money supplyM1M2M3M4

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Practical view

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Assumption

• There is a single bank (monopoly bank)

• The bank accepts only demand deposits

• The banks CRR requirement is 20%• And excess reserve requirement is

12%• The banks holds its assets only in the

form of cash reserves and loans & advances.

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LABLITIES Rs . ASSETS Rs .

A ‘s deposit 100.00 Cash Reserve

Ratio(CRR) 20.00

Excess reserves 80.00

Total 100.00 Total 100.00

Money creation leads to money supply

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LABLITIES Rs . ASSETS Rs.

A ‘s deposit

100.00 CRR(20+16) 36.00

B’s deposit 80.00 Loan to B 80.00

Excess cash reserves 64.00

TOTAL 180.00 Total 180.00

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LABLITIES Rs . ASSETS Rs .

A ‘s deposit 100.00 CRR(20+16+……) 100.00

B’s deposit 80.00 Loan to B 80.00

…………. ……. ……………. …….

Net deposit 00.00 Excess cash reserve 00.00

TOTAL 500.00 Total 500.00

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How RBI measures Money supply

M1 = C + DD + OD

where, C = Currency held by the public

DD = Net demand deposits with the bank

OD = Other deposits with RBI

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The estimate of money stock(m3)in India as on 31st March 2004

Items MoneySupply

Rs. In cr.% Share

I. Stock of money(a+b+c+d)

a. Currency with publicb. Demand deposit with

bankc. Time deposit with publicd. Other deposit with R.B.I

II. Reserve money(a+b+c)(Reserve Money as % of

stock of money=21.82%)a. Currency in circulationb. Bankers deposit with the

R.B.Ic. Other deposit with R.B.I

2000349

316758251371

14271795041

436429

327023104365

5041

100.00

15.8312.57

71.370.25

100.00

74.9323.91

1.16

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Case study

Reserve money (M0)

Narrow money (M1)

Broad money (M3)

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Money multiplier

Monetization of economy

Case study

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Does money have future..?

• RBI’s control has been loosened.

• Supply of money is affected.