Class 12 Macroeconomics Chapter 3: Money and Banking Notes
These Money and Banking Class 12 Notes explain the meaning, functions and importance of money in a modern economy along with the role of banks and the Reserve Bank of India. The chapter discusses barter system, money supply, credit creation, money multiplier and monetary policy instruments used by RBI.
These NCERT notes are prepared for quick revision and competitive exam preparation, covering important concepts, formulas, banking systems, monetary tools and exam-oriented topics useful for UPSC, SSC, State PSC, Railways, CUET and board examinations.
Table of Contents
- Chapter Overview
- NCERT Notes
- Meaning of Money
- Functions of Money
- Cashless Economy
- Demand for Money
- Supply of Money
- Central Bank
- Commercial Banks
- Money Creation by Banking System
- Money Multiplier
- Policy Tools to Control Money Supply
- Demand and Supply for Money
- Measures of Money Supply
- Fiat Money and Legal Tender
- Demonetisation
- Important Topics
- Important Questions
- FAQs
- Quick Revision Summary
Chapter Overview
Money and Banking explains how money acts as a medium of exchange, store of value and unit of account in the economy. The chapter highlights the evolution from barter system to modern banking and digital transactions. (Pages 36–37)
The chapter further explains demand and supply of money, functions of commercial banks, role of RBI, money creation process, money multiplier and monetary policy instruments such as CRR, repo rate and open market operations. (Pages 38–49)
NCERT Notes
Meaning of Money (Pages 36–37)
These NCERT Notes on Money and Banking explain the concept of money and its importance in facilitating exchange in modern economies.
Meaning of Money
Money is the commonly accepted medium of exchange.
Barter System
Exchange of goods and services without using money.
Drawback of Barter System
- Lack of double coincidence of wants
Functions of Money (Pages 36–37)
These notes explain the major functions performed by money in an economy.
1. Medium of Exchange
Meaning
Money facilitates buying and selling of goods and services.
Importance
- Removes difficulties of barter exchange
- Reduces transaction costs
2. Unit of Account
Meaning
Money measures value of goods and services.
Example
- Pen price = ₹10
- Pencil price = ₹2
- Relative price can be calculated easily
3. Store of Value
Meaning
Money can be saved and used in future.
Importance
- Durable
- Easily transferable
- Universally acceptable
Cashless Economy (Page 37)
These notes explain the growing importance of digital payments and financial inclusion in India.
Features
- Digital transactions
- e-Wallets
- Aadhaar enabled payment systems
- Mobile banking
Government Initiatives
- Jan Dhan Accounts
- National Financial Switch (NFS)
Demand for Money (Page 37)
These NCERT notes explain the factors determining the demand for money in the economy.
Meaning
Demand for money refers to the desire to hold money balances.
Determinants
- Income
- Rate of interest
Relationship
- Higher income → Higher demand for money
- Higher interest rate → Lower demand for money
Supply of Money (Pages 38–39)
These notes explain the meaning and components of money supply.
Components of Money Supply
- Currency
- Bank deposits
Institutions Creating Money
- Central Bank
- Commercial Banks
Central Bank (Page 38)
These notes explain the role and functions of the Reserve Bank of India.
Reserve Bank of India (RBI)
Established
1935
Major Functions
- Issues currency
- Controls money supply
- Banker to government
- Custodian of foreign exchange reserves
- Banker to commercial banks
High Powered Money
Meaning
Currency issued by RBI used as base for credit creation.
Other Names
- Reserve Money
- Monetary Base
Commercial Banks (Pages 38–39)
These NCERT notes explain the role and functioning of commercial banks in the economy.
Functions of Commercial Banks
- Accept deposits
- Provide loans
- Create credit
Bank Profit
Difference between:
- Interest received on loans
- Interest paid on deposits
This difference is called spread.
Money Creation by Banking System (Pages 39–42)
These notes explain how banks create money through lending and deposit creation.
Balance Sheet of Bank
Assets
- Reserves
- Loans
Liabilities
- Deposits
Formula for Assets and Liabilities
Assets = Reserves + Loans
Liabilities = Deposits
Net Worth = Assets − Liabilities
Money Supply Formula
M1 = Currency + Deposits
Cash Reserve Ratio (CRR)
These notes explain the reserve requirement maintained by commercial banks.
Meaning
Percentage of deposits banks must keep as reserves with RBI.
Formula
CRR = (Cash Reserves / Deposits) × 100
Statutory Liquidity Ratio (SLR)
Meaning
Banks must maintain some reserves in liquid assets.
Money Multiplier (Pages 41–42)
These NCERT notes explain how an initial deposit leads to multiple credit creation in the banking system.
Formula
Money Multiplier = 1 / CRR
Example
If CRR = 20%
Money Multiplier = 1 / 0.20 = 5
Thus:
- ₹100 reserves create ₹500 deposits
Policy Tools to Control Money Supply (Pages 42–43)
These notes explain the quantitative and qualitative tools used by RBI to control money supply.
Quantitative Tools
1. Cash Reserve Ratio (CRR)
- Higher CRR → Lower money supply
- Lower CRR → Higher money supply
2. Open Market Operations (OMO)
Meaning
Buying and selling government securities in open market.
Effects
- RBI buys securities → Money supply increases
- RBI sells securities → Money supply decreases
3. Repo Rate
Meaning
Rate at which RBI lends money to commercial banks.
Effect
- Higher repo rate → Lower money supply
- Lower repo rate → Higher money supply
4. Reverse Repo Rate
Meaning
Rate at which RBI borrows money from commercial banks.
5. Bank Rate
Meaning
Rate charged by RBI on loans to commercial banks.
Demand and Supply for Money: Detailed Concepts (Pages 43–47)
These NCERT notes explain transaction demand and speculative demand for money.
Transaction Motive
Meaning
Money held for day-to-day transactions.
Formula
MdT = kT
Where:
- MdT = Transaction demand for money
- T = Total value of transactions
- k = Positive fraction
Velocity of Circulation of Money
Formula
v = 1 / k
Where:
- v = Velocity of circulation of money
Transaction Demand in Terms of GDP
Formula
MdT = kPY
Where:
- P = Price level
- Y = Real GDP
Key Point
Transaction demand for money is positively related to:
- Real income
- Price level
Speculative Motive (Pages 45–47)
These notes explain demand for money as an alternative to holding bonds.
Key Point
Speculative demand for money is inversely related to rate of interest.
Bond Price and Interest Rate Relationship
Key Point
Bond price and market rate of interest are inversely related.
Speculative Demand Formula
MdS = (rmax − r) / (r − rmin)
Where:
- r = Market rate of interest
- rmax = Maximum interest rate
- rmin = Minimum interest rate
Liquidity Trap
Meaning
Situation where people hold money instead of bonds due to very low interest rates.
Key Point
Speculative demand for money becomes infinitely elastic.
Total Demand for Money Formula
Md = MdT + MdS
or
Md = kPY + (rmax − r) / (r − rmin)
Measures of Money Supply (Pages 47–48)
These notes explain different measures of money supply used in India.
M1 (Narrow Money)
Formula
M1 = CU + DD
Where:
- CU = Currency held by public
- DD = Net demand deposits of commercial banks
Features of M1
- Most liquid measure of money supply
- Includes currency and demand deposits
- Called narrow money
M2 Formula
M2 = M1 + Savings Deposits with Post Office Savings Banks
Features of M2
- Includes M1 plus post office savings deposits
- Slightly less liquid than M1
M3 Formula
M3 = M1 + Net Time Deposits of Commercial Banks
Features of M3
- Most commonly used measure of money supply in India
- Called broad money
- Includes time deposits like fixed deposits
M4 Formula
M4 = M3 + Total Deposits with Post Office Savings Organisations
Features of M4
- Broadest measure of money supply
- Includes all post office deposits
Difference Between Narrow Money and Broad Money
| Basis | Narrow Money | Broad Money |
|---|---|---|
| Liquidity | Highly liquid | Less liquid |
| Includes | Currency + demand deposits | Includes time deposits |
| Measures | M1, M2 | M3, M4 |
Fiat Money and Legal Tender (Page 48)
These notes explain the legal nature of currency notes and coins.
Fiat Money
Meaning
Money having value because government declares it acceptable.
Legal Tender
Meaning
Money that cannot legally be refused for payments.
Example
- Currency notes
- Coins
Demonetisation (Page 49)
These notes explain the 2016 demonetisation initiative in India.
Meaning
Withdrawal of legal tender status of old ₹500 and ₹1000 notes.
Objectives
- Control black money
- Reduce fake currency
- Control corruption
- Promote digital payments
Positive Effects
- Increase in tax compliance
- Rise in digital transactions
- More money entered formal banking system
Negative Effects
- Temporary cash shortage
- Long queues outside banks
- Short-term disruption in economic activities
Important Topics
| Important Topic | Page Reference |
|---|---|
| Meaning of Money | Pages 36–37 |
| Functions of Money | Pages 36–37 |
| Demand for Money | Page 37 |
| Supply of Money | Pages 38–39 |
| Reserve Bank of India | Page 38 |
| Commercial Banks | Pages 38–39 |
| Credit Creation | Pages 39–42 |
| Money Multiplier | Pages 41–42 |
| Open Market Operations | Pages 42–43 |
| Repo and Reverse Repo Rate | Pages 42–43 |
| Transaction Demand for Money | Pages 43–44 |
| Speculative Demand for Money | Pages 45–47 |
| Liquidity Trap | Page 47 |
| Measures of Money Supply | Pages 47–48 |
| Fiat Money | Page 48 |
| Demonetisation | Page 49 |
Looking for other chapters notes?
Introduction to Macroeconomics Class 12 Notes
National Income Accounting Class 12 Notes
Determination of Income and Employment Class 12 Notes
Government Budget and the Economy Class 12 Notes
Class 12 Economics Chapter 6: Open Economy Macroeconomics Notes
Important Questions
Very Short Answer Questions
- What is barter exchange? (Pages 36–37)
- Define money supply. (Pages 38–39)
- What is CRR? (Pages 40–41)
- Define repo rate. (Pages 42–43)
- What is liquidity trap? (Page 47)
Short Answer Questions
- Explain the functions of money. (Pages 36–37)
- Explain the functions of commercial banks. (Pages 38–39)
- Explain money multiplier with example. (Pages 41–42)
- Differentiate between narrow money and broad money. (Pages 47–48)
- Explain open market operations. (Pages 42–43)
Long Answer Questions
- Explain the process of credit creation by commercial banks. (Pages 39–42)
- Discuss the instruments of monetary policy used by RBI. (Pages 42–43)
- Explain transaction and speculative demand for money. (Pages 43–47)
- Discuss the measures of money supply in India. (Pages 47–48)
- Explain the concept and impact of demonetisation. (Page 49)
FAQs
1. What is money?
Money is a commonly accepted medium of exchange.
2. What are the functions of money?
Money acts as medium of exchange, unit of account and store of value.
3. What is money multiplier?
Money multiplier shows how initial reserves create multiple deposits in banking system.
Money Multiplier = 1 / CRR
4. What is CRR?
Cash Reserve Ratio is the percentage of deposits banks must keep with RBI.
5. What is liquidity trap?
Liquidity trap is a situation where people prefer holding money instead of bonds due to very low interest rates.
Quick Revision Summary
- Money solves barter problems.
- Main functions:
- Medium of exchange
- Store of value
- Unit of account
- RBI is India’s central bank.
- Commercial banks create credit.
- Money multiplier formula:
Money Multiplier = 1 / CRR
- Demand for money depends on:
- Income
- Interest rate
- Transaction demand formula:
MdT = kPY
- Velocity of circulation:
v = 1 / k
- Total money demand:
Md = MdT + MdS
- M1 and M2 are narrow money.
- M3 and M4 are broad money.
- RBI controls money supply using:
- CRR
- Repo rate
- Bank rate
- Open market operations
- Liquidity trap occurs when interest rate becomes extremely low.
- Demonetisation aimed to reduce black money and promote digital payments.