MULUNGUSHI UNIVERSITY

SCHOOL OF BUSINESS STUDIES

PROGRAMME: BARCHELORS DEGREE IN LAW (BLL1)

COURSE: INTRODUCTION TO MACROECONOMICS

COURSE CODE: SSE122

STUDENT NUMBER: 202110067

LECTURER: MRS REINKE

DUE DATE: 31ST MARCH, 2022

 QUESTION NUMBER ONE: MONEY AND BANKING

1. What is Monetary Policy? Identify the key instruments used by this policy to control
the flow and volume of money supply in the system

i. Monetary policy refers to any conscious or deliberate actions of the monetary

authorities, mostly central banks, to control or change the quantity, availability or cost
of money in an economy in order to achieve laid down goals or objectives. It is also a
combination of policy measures designed by a central bank to control the quantity of
money and cost of credit in the economy in consonance with the expected level of
economic activity. In other words, monetary policy is the process by which the
central bank or monetary authorities of a country controls the supply, availability and
cost of money in order to attain a set of objectives, usually geared towards promoting
national economic goals It is, therefore, the deliberate actions taken by the central
bank to stabilize the economy.
ii. Monetary policy is used by central banks for the purpose of achieving certain national
goals or objectives. These goals, which are in line with basic macroeconomic
objectives includes low unemployment rate, stable prices, high output growth rate,
low inflation rate and stable exchange rate. These objectives are simply referred to as
goals or as ultimate goals of monetary policy. In order to achieve these goals, central
banks usually use indirect means which involves choosing the tools or instruments
they can directly control, use or operate. These instruments are commonly referred to
as instruments of monetary policy.

Among the instruments at the disposal of central banks are;

i. Bank rate or monetary policy rate or rediscount rate: This is the rate at which the
central banks lend to or discount bills held by commercial banks and other
institutions.
ii. Open market operation (OMO): This is simply the purchase or sale by the central
bank of securities in financial markets
iii. Reserve requirements: Often expressed in percent is the minimum reserves
commercial banks must hold in their vaults and the central bank against the public’s
deposit with them.
iv. Selective control: Selective control is meant to impact certain sectors rather than the
whole economy in order to either satisfy social priorities, control the destabilizing
nature of certain sectors or use the critical position of certain sectors for stabilization
purposes.
v. Moral suasion. This is the use of the influence of the central bank upon commercial
banks to follow its suggestions and recommendations which are believed to be in the
interest of the whole economy.
2. Give the meaning, functions and classifications of money
i. Meaning of money

Money can be defined as anything that is generally acceptable as a means of exchange and
that at the same time acts as a measure and as a store of value.

ii. Functions of money

There are generally four major functions of money. These functions are listed below as
follows;

a. Money is a medium of exchange: This may be considered as the most basic function of
money. Money has the quality of general acceptability. As such, all exchanges take place
in terms of money.
b. Money is a measure of value: This simply means that prices of all goods and services are
expressed in terms of money. Since all values are expressed in terms of money, it is
easier to determine the rate of exchange between various types of goods and services in
the community. For example, if the price of bag X is K10, and the price of bag Y is K30,
then value of bag Y is higher than the value of bag X.
c. Money as a standard of deferred payments: This simply means that money enables
people to have immediate use of goods or services but pay for such goods or services at a
future date.
d. Money is a store of value: To act as a store of value, money must be able to be reliably
saved, stored, and retrieved. Money serves as an excellent store of wealth, as it can be
 easily converted into other marketable assets, such as, land machinery, plant etc., but
money can perform this function satisfactorily only if its own value is fairly stable.

iii. Classifications of money

Different economists have classified money on the basis of different criteria. On the basis of
legality, money can be classified under two heads; legal tender money and optional money.

a. Legal tender money: This is money which is accepted as a means of payment both by
the government as well as the people. This type of money has legal sanction behind it.
No one can refuse to accept it as a means of payment. Legal tender money can be
further subdivided under two heads which are limited legal tender and unlimited legal
tender.
b. Optional money: This is money which ordinarily is accepted by the people, but has
no legal sanctions behind it. No one can be forced to accept this type of money
against his or her wishes. Different types of credit instruments like cheques and bills
of exchange are examples of optional money.

Money can be classified under two sub-heads on the basis of the commodity used in
making it. These are metallic money and paper money.

c. Metallic money: This money is made of a particular metal such as gold, silver, copper
and nickel. Metallic Money is further classified under three sub heads: standard
money and token money.
d. Standard money: This is also referred to as the principle money or full-bodied
money. Standard coins are made of gold or silver. Standard coin refers to a coin
whose face value or exchange value is equal to its intrinsic value. These coins are
made of a well-defined weight and fineness.
e. Token money: Token money is used for making smaller payments. It serves as a
subsidiary for standard money. Token coin refers to a coin' whose face value of
exchange value is more than its intrinsic value. It is generally made of inferior and
light metals, such as copper and nickel.
 f. Representative paper money: This type of paper money is fully backed up by fold
and silver reserves. In the beginning to avoid wastage of metals the paper currency
was issued. Hence, the monetary authority maintained metallic reserves equivalent to
the value of paper notes issued. The demand for converting paper notes into cash was
met by making use of gold and silver kept in reserves. Thus, under the system of
representative paper money, gold and silver equivalent to the value of paper notes
issued were kept in reserves by the monetary authority.
g. Convertible paper money: It refers to that type of paper money, which is convertible
into standard coins at the option of the holder.
h. Inconvertible paper money: This system prevails in a country when the monetary
authority gives no guarantee to convert the paper notes into coin or other valuable
metals. Such a type of paper currency circulation account of the high credit enjoyed
by the monetary authority.
i. Fiat money: Lastly, this is only a variety of in convertible fiat money and is issued
generally at a time of crisis. That is why it’s sometimes referred to as emergency
currency. No reserves of any type are kept behind and are neither backed up by the
metallic and fiduciary cover. The monetary authority gives no guarantee to convert
fiat money into metallic coins.

3. What is the Quantity theory of money? Explain the Keynesian approach to liquidity
preference
i. The Quantity theory of money (QTM) states that the general price level of goods and
services are proportional to the money supply in an economy. According to the
Quantity theory of money, if the amount of money in an economy doubles, all else
equal, price levels will also double. This results in a consumer paying twice as much
for the same amount of goods and services. This increase in price levels will
eventually in a raising inflation level. The Quantity theory of money is expressed in
the following formula; MV= PT. Whereas as M means money supply; V means
velocity or speed of circulation of money; P means the general price level and T
means the volume of transactions.
ii. The Keynesian approach to liquidity preference is named after John Maynard Keynes
(1883-1946) who was a British economist whose ideas still influence academics and
government policy makers. Liquidity preference is his theory about the reasons
people hold cash; economists call this a demand-for-money theory. The theory asserts
that people prefer cash over other assets for three specific reasons.
a. Transaction motive: Keynes dubbed the first of his three reasons people want
to hold cash the transactions motive. People want to have money available so
they can conveniently buy things. The alternative, putting money into an asset
such as bonds and selling the bonds to purchase something, is far too
burdensome. This motive is related to income. Keynes noted that the more
money people make, the more they purchase. The more people purchase, the
more cash they need to have on hand.
b. Precautionary motive: The precautionary motive is also related to income.
People want to have cash readily available in case of an unforeseen incident,
such as unemployment, accident or illness, and those with larger incomes
need more money should such situations arise. Keynes precautionary motive
predicts that people with larger incomes will hold more cash as a contingency
measure.
c. Speculative motive: Keynes argued that when interest rates are low, the
demand for money is greater. He called this the speculative motive because,
when interest rates go up, people will hold less cash and instead hold more
bonds. In other words, the higher the interest rate, the lower the speculative
demand for money. People would rather earn the higher rate of interest than
hold the cash and earn no interest.
4. Distinguish between the definition and functions of commercial banks from the
central bank

A commercial bank is a financial institution that carries all the operations related to deposit
of surplus funds, safeguard and withdrawal of money for the general public, providing loans
for investment and such other activities. The aim is to earn a profit.
The following are some of the functions of commercial banks as distinguished from those of
central banks;

i. Commercial banks accept and safeguard deposits in form of current, savings and
fixed deposit from the general public.
ii. Commercial banks provide advise to the customers on different products, business
growth and development, feasibility of business and industry and such other related
advise
iii. Commercial banks are entrusted to with the responsibility of purchase and sale of
shares and securities at the stock exchange market on behalf of customers
iv. Commercial banks finance the business community of a country through loans and
overdrafts
v. Commercial banks act as trustees on behalf of their customers and provide safe
custody of wills and other vital documents

Whereas a central bank is defined as a financial institution given a privileged control over the
production and distribution of money and credit for a nation. The central bank is the principle
financial institution in a country and acts as a regulator of the banking system. Every country
of the world has a central bank. Central banks provide services to commercial banks and the
government of a country. It does not deal or provide services directly to the general public.

The following are some of the functions of a central bank as distinguished from those of a
commercial bank;

i. Central banks ensure appropriate monetary policy formulation and implementation

ii. Central banks provide banking services to a government, commercial banks and acts
as settlement agent
iii. Central banks license, regulate and supervise banks and financial service institutions
iv. Central banks ensure a safe and sound financial system
v. Central banks issue currency in the form of notes and coins
vi. Central banks are lenders of last resort
vii. Central banks manage public debt
viii. Central banks are custodians of a country’s stocks of gold and foreign exchange
reserves
 ix. Central banks collect and interpret statistics, in particular, financial and monetary
statistics
x. Central banks carry various international monetary duties with foreign central banks,
the World Bank and the International Monetary Fund among other institutions.
xi. Central banks implement balance of payments policy.
5. How do commercial banks make their profits? Explain the process in detail.

Commercial banks make their profits through the process known as credit creation.
Commercial banks like all other companies need to earn profit for their shareholders.
Commercial banks create credit by advancing loans and purchasing securities. They lend
money to individuals and businesses out of the deposits accepted from the general public.
However, commercial banks cannot use the entire amount of public deposits for lending
purposes. They are required by the law of the country to keep a certain amount or percentage
as reserve with the central bank for serving the cash requirements of customers. After
keeping the required amount or percentage of reserves, commercial banks can lend the
remaining portion of public deposits.

For instance, suppose individual X deposits K10, 000 with Bank A which is the primary
deposit of the bank. The cash reserve requirement of the central bank is 10% of the country
Bank A is conducting business. In this case, Bank A would keep K1, 000 as reserve with the
central bank as required and would use the remaining K9, 000 for lending purposes. The
Bank lends K9, 000 to individual Y by opening an account in his name, known as demand
deposit account.

QUESTION TWO (2): PUBLIC FINANCE

1. What is Fiscal Policy?

Fiscal policy is defined as the use of government spending and taxation to influence the
economy. Governments typically use fiscal policy to promote strong and sustainable growth and
reduce poverty.

2. Explain the role of government in the economy

 i. The allocation function: A government must provide certain public goods and
services which the private sector fails to provide because there exists no market for
them. The reason for a government to provide such goods and services is for the
benefit of the general public. For instance, government should provide services in
areas such as education, health, and defence because of the nature of such sectors.
ii. The distribution function: The government should through its fiscal policies attempt
to bring out income redistribution in the economy that is fair to all its citizens. The
government may transfer payments from one citizen to another through its fiscal
policies. This is done through various schemes such as subsidies, minimum wage
legislation and free basic services in health and education.
iii. Stabilization function: The government should balance supply and demand by using
fiscal and monetary policies. The economy tends to undergo periods of fluctuations
and instability. The periods of fluctuations may lead to high unemployment rate,
inflation and increase in prices of commodities. Such unpredictable periods require
government intervention.
iv. Commercial functions: Also referred to as the economic growth functions, the state
undertakes commercial activities where the private sector is not attracted to undertake
projects of national interest. In some cases projects yield profits only in the long-run
and they need big capital expenditure e.g. power projects and road networks. In such
cases the private sector is reluctant to invest in them. The state therefore has to
undertake such commercial activities
3. What is government budget

A government budget is a statement containing a forecast of revenues and expenditure for a

period of time, usually a year. It is a comprehensive plan of action designed to achieve the policy
objectives set by the government for the coming year. A budget is a plan and a budget document
is a reflection of what the government expects to do in future. Its shows detailed allocation of
resources and proposed taxation or other measures for their realisation.

4. What is Public debt? Explain the concepts of Budget deficit, Revenue deficit and
Fiscal deficit
i. Public debt or sometimes referred to as government debt represents the total
outstanding debt of a country’s government. It is a measure of government
indebtedness. Public debt comprises of domestic and external debt, where domestic or
internal debt represents the government’s obligations to domestic lenders and external
debt is the debt owed to lenders outside the country. It is often expressed as a ratio of
Gross Domestic Product (GDP).
ii. Budget deficit is defined as the difference between what the government spends and
what it collects as revenue in a given period. Budget deficit exist when, during a
certain period of time, public expenditures become higher than the public income.
iii. Revenue deficit occurs when the realized net income or revenue is less than the
projected or predicted net income or revenue in a given period of time. This happens
when the actual amount of revenue or the actual amount of expenditures do not
correspond with the budgeted revenue and expenditure.
5. What is the position of Fiscal Discipline in Zambia? Use figures (empirical evidence)
to explain your answer.

Fiscal discipline is defined as the ability of a government to sustain smooth monetary

operation and long standing fiscal conditions.