2.8 The role of money and financial markets

Question 1

Define money

Answer 1

Anything that is acceptable as a means of payments for goods and services

Question 2

Define medium of exchange

Answer 2

Anything that sets the standard of value of goods and services acceptable to all parties involved in a transaction

Question 3

Define financial sector

Answer 3

Consists of financial organisations and their products and involves the flow of capital

Question 4

Explain the role of the financial sector for the economy

Answer 4

• Helps consumers, firms and governments to carry out economic activities, and therefore helps the market to work
• Involves the lending and borrowing of money through banks and building societies
• Banks and building societies enables people who do not need to use money now (savers) to provide for those who do need it now (borrowers). This allows for supply of money, from savers, to equal demand for money, from borrowers.

Question 5

Define banks

Answer 5

Financial institutions licensed to receive deposits and make loans

Question 6

Define building societies

Answer 6

Mutual financial organisations that are owned by their members

Question 7

Define insurance

Answer 7

A contract in which an individual or organisation receives financial protection or reimbursement against losses, from an insurance company

Question 8

Explain the role of building societies

Answer 8

• Mutual organisations
• Owned by members, who are savers with them
• Provide a limited range of services, mainly savings and mortgages
• Limited as to how much money can be borrowed from the money market

Question 9

Explain the role of banks

Answer 9

• Owned by shareholders
• Wide range of services (e.g. accept deposits, issue bank notes etc)
• Can borrow widely on the money market

Question 10

Explain the role of insurance companies

Answer 10

• Life insurance: pays out money to the surviving family. Intended to help replace the loss of income due to death.
• General insurance: All non-life aspects (e.g. property, motor, health etc)

Question 11

Why is credit provision important for consumers?

Answer 11

Consumers can buy not, pay later and therefore increase consumption

Question 12

Why is credit provision important for producers?

Answer 12

Producers can borrow money to expand

Question 13

Why is credit provision important for the government?

Answer 13

The government can run a budget deficit or spend before taxes are collected

Question 14

Example of roles that the financial sector created

Answer 14

• Credit provision
• Liquidity provision

Question 15

Why is liquidity provision important for consumers?

Answer 15

Can borrow to pay later (often against an asset like a house)

Question 16

Why is liquidity provision important for producers?

Answer 16

Banks will provide overdraft facilities so firms can continue trading while waiting for payments

Question 17

Define interest rates

Answer 17

The cost of borrowing money

Question 18

Define saving

Answer 18

The part of an individual’s income which is not spent on consumption

Question 19

Define borrowing

Answer 19

Receiving something of value in exchange for an obligation to pay it back at a specified time in the future

Question 20

Define investment

Answer 20

The purchase of capital goods that are used to produce future goods and services. It is also an asset purchased to provide an income in the future and/or be sold for profit

Question 21

How do interest rates affect the levels of savings?

Answer 21

• As the rate of interest increases, people tend to save more
• As the rate of interest decreases, people tend to save less

Question 22

How do interest rates affect the levels of borrowing?

Answer 22

• Increased interest rates lead to less borrowing/more saving

Question 23

How do interest rates affect the levels of investment?

Answer 23

• As the rate of interest increases, the levels of investment decreases.
• As the rate of interest decreases, the levels of investment increases.