Money and Banking

Lesson

Part 1 — barter, the functions of money, the money supply and how banks create money.

In this lesson you will

Explain the problems of barter and the four functions of money
Identify the components of the money supply (M1) and calculate it from data
Explain how commercial banks create deposits and calculate total deposits and credit with the money multiplier
Explain why actual deposit creation is smaller than the formula suggests

Part 1 at a glance

Concept

Life without money: barter

Under barter, goods are exchanged directly for goods. It breaks down as soon as an economy grows.

Table of five problems of barter with an imagined example and how money solves each: double coincidence, a common measure of value, indivisibility, storing value and future payments
Problem of barter	What goes wrong (imagined example)	How money solves it
No double coincidence of wants	A potter wants rice; the rice farmer wants cloth	Sell pots for money, buy rice with money
No common measure of value	How many kilos of rice is one goat worth?	Every good gets a price in rupees
Indivisibility of goods	A cow cannot be split to buy a pair of sandals	Money comes in small units
Difficulty of storing value	Fish and grain rot; cattle need feed	Money keeps value and is easy to keep
No standard for future payments	Repay a loan in grain of what quality?	Debts are stated in rupees

Check your understanding

A potter wants rice, but the rice farmer wants cloth. Which drawback of barter is this?

Multiple choice1 mark

A potter wants rice, but the rice farmer he meets wants cloth, not pots. Which drawback of the barter system does this show?