Economics

Supply of money

Q: If the central bank changes money supply, why will it be studied in macroeconomics?

Because it can affect interest rates, demand and output A central bank's change in money supply is a monetary-policy action that can influence interest rates, credit conditions, aggregate demand, investment, output and inflation. These are economy-wide variables, so the issue belongs to macroeconomics rather than to one family, shop or product.

Q: Through which chain can the macroeconomic effect of an increase in money supply be understood?

Interest rate, demand, output, and prices An increase in money supply can reduce interest rates when liquidity is available, encouraging borrowing, consumption, and investment. These changes may raise aggregate demand and output in the short run, while stronger demand can also create price pressures. The exact effect depends on expectations, spare capacity, and monetary transmission.

In Class 12 Economics, the topic “Supply of Money” explains the total stock of money available to the public in an economy at a given point in time. Students examine its main components—currency held by the public and demand deposits with commercial banks—and understand how broader measures may include time deposits. The topic also introduces the role of banks and the central bank in creating, regulating, and measuring money supply, linking deposits, credit creation, and monetary control to the functioning of the financial system.

Medium · Level 1 · 3 questions

Practice questions

01If the central bank changes money supply, why will it be studied in macroeconomics?

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Answer and explanation

Correct answer: B. Because it can affect interest rates, demand and output

A central bank's change in money supply is a monetary-policy action that can influence interest rates, credit conditions, aggregate demand, investment, output and inflation. These are economy-wide variables, so the issue belongs to macroeconomics rather than to one family, shop or product.

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02Through which chain can the macroeconomic effect of an increase in money supply be understood?

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Answer and explanation

Correct answer: B. Interest rate, demand, output, and prices

An increase in money supply can reduce interest rates when liquidity is available, encouraging borrowing, consumption, and investment. These changes may raise aggregate demand and output in the short run, while stronger demand can also create price pressures. The exact effect depends on expectations, spare capacity, and monetary transmission.

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03Why is the effect of money supply not limited only to the quantity of money in macroeconomics?

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Answer and explanation

Correct answer: B. Because it can influence interest rates, credit availability, investment, aggregate demand and the general price level.

Money supply is an important macroeconomic variable because a change in it can alter the liquidity available in the banking system. Greater liquidity may reduce interest rates, encourage borrowing and investment, raise aggregate demand and affect output and employment in the short run. If the expansion is excessive relative to production, it may also create inflationary pressure and raise the general price level. Therefore, its effects extend beyond the mere quantity of money and are studied through monetary policy.

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Supply of money

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