Money, Banking and Households: Economics 0455 (Cambridge O Level / IGCSE)

Nabil keeps a small herd of goats and wants to buy a second-hand bicycle from Deng, who repairs and resells bikes locally. The bicycle is priced at $40. Nabil offers to swap it for one of his goats instead, but a single goat is worth roughly $200 to Deng, and cutting a live goat into a smaller piece would kill the animal and destroy almost all of its value. Since neither of them can turn one goat into a $40 portion, Deng ends up refusing the goat and accepting $40 in cash instead.

Which characteristic of money best explains why Deng could accept payment in cash for the bicycle, but not directly in the form of part of a goat?

The government of Velmora has just established the Velmora Central Bank (VCB), the country's first central bank. Two long-established commercial banks, Portside Bank and Union Trust, continue to operate high-street branches across the country.

• Portside Bank accepts savings deposits from local households and uses these funds to make loans to small businesses that are opening new shops.
• The VCB has, for the first time, set Velmora's official rate of interest and is now the only institution permitted to issue Velmora's banknotes.
• When Union Trust suffered a sudden loss of confidence from its depositors and could not find enough funds to meet a wave of withdrawals, it was the VCB, rather than Portside Bank, that lent Union Trust the money it needed to stay open.

(a) Identify two activities described above that are normally carried out by a commercial bank rather than a central bank. [2]

(b) Identify two activities described above that are normally carried out by a central bank rather than a commercial bank. [2]

(c) Explain why it was the VCB, rather than Portside Bank, that stepped in to lend money to Union Trust when it faced this loss of depositor confidence. [2]

Fatou works as a nurse and currently earns a monthly income of $1800. She spends $1600 of this each month and saves the remaining $200. Fatou has just been offered a promotion that would raise her monthly income to $2400, and she plans to keep her monthly spending fixed at $1600 if she takes it.

(a) Calculate Fatou's monthly saving as a percentage of her monthly income, both before and after the promotion. Give each answer correct to 1 decimal place. [2]

(b) Using Fatou's figures from part (a), explain why a rise in income tends to increase the amount a household saves. [2]

(c) Fatou is also considering taking out a bank loan now to buy a car, rather than waiting until she has saved enough to buy it outright. Explain one reason why her higher income might make both Fatou and the bank more willing to go ahead with this loan now. [2]

A national survey in the country of Karsova shows that, over the past year, a growing share of households now believe their jobs are secure and expect the economy to keep growing. Household income and the rate of interest have not changed over this period.

Assuming this rise in household confidence is the only change taking place, what is the most likely combined effect on household spending and household saving?

Boluwatife is 22 and has just started his first job after finishing his final exams. His aunt, Ngozi, is 61 and plans to retire from work in four years' time. Boluwatife and Ngozi currently earn a similar monthly income, and both live in the country of Azurel.

In Azurel, it is a widespread cultural expectation that adult children will financially support their parents once they retire, and, as a result, a relatively small proportion of national income is saved by households. In the neighbouring country of Vantoria, the state pension is very limited, and it is a longstanding cultural expectation that individuals are responsible for funding their own retirement; average household saving as a proportion of income is much higher in Vantoria than in Azurel.

(a) State which of the two influences on household saving, age or culture, best explains (i) the likely difference in saving between Boluwatife and Ngozi, and (ii) the difference in average household saving between Azurel and Vantoria. [2]

(b) Explain why Ngozi is likely to save a larger proportion of her income than Boluwatife, even though they currently earn a similar income. [3]

(c) Analyse why average household saving is higher in Vantoria than in Azurel, using the information given about the two countries. [3]

Aiko runs a small stall selling handwoven baskets. Today she sold three baskets and was paid $60 in cash. Rather than spending all of today's earnings straight away, Aiko deposits most of the $60 into her savings account, planning to use it to buy more materials in three months' time.

Which function of money is best illustrated by Aiko depositing her earnings to use again in three months' time, rather than spending them today?

Osei owns a bicycle repair shop. Over one week, four separate events take place.

• Event 1: A customer pays Osei $15 in cash for a puncture repair, and Osei uses that same cash later in the day to buy spare inner tubes from his supplier.
• Event 2: Osei prices each type of job in dollars, for example $15 for a puncture repair and $45 for a full service, so that customers can compare the two jobs before deciding which they can afford.
• Event 3: Osei banks part of that week's takings and does not spend it, planning to use the saved amount in six months' time to buy a second-hand delivery van.
• Event 4: A regular customer, Mariam, cannot pay the full $45 service fee today. Osei agrees that she can pay him the $45 next month instead, once she has been paid at the end of her work contract.

(a) Identify the function of money illustrated by Event 1, and the function of money illustrated by Event 2. [2]

(b) Explain the function of money illustrated by Event 3. [2]

(c) Explain the function of money illustrated by Event 4. [2]

Amara deposits $5000 into a savings account at Silverbrook Bank, which pays her 2% interest per year on this balance. Silverbrook Bank lends $5000 to Tomasz, a local baker who wants to buy a new oven, charging him 7% interest per year on the loan. Amara also uses a debit card issued by Silverbrook Bank to pay her monthly rent electronically, without needing to withdraw or carry cash.

(a) Describe, step by step, the process by which Silverbrook Bank turns the money Amara deposits into a loan that Tomasz can use to buy his oven. [3]

(b) Calculate the interest Silverbrook Bank pays Amara in one year and the interest it receives from Tomasz in one year, and hence calculate the bank's profit on this pair of transactions in one year. [2]

(c) Identify and explain one service, other than accepting deposits and making loans, that Silverbrook Bank provides to Amara in this scenario. [2]

Yusuf has $3000 in a savings account, earning his country's official rate of interest, currently 3% per year. He is also considering taking out a $4000 loan to renovate his kitchen, at the same 3% annual rate of interest. To keep the numbers simple, assume the same rate of interest applies to both his savings and this loan. The central bank has just raised the official rate of interest from 3% to 6%.

(a) Calculate the interest Yusuf's $3000 in savings would earn in one year, both at the original 3% rate and at the new 6% rate. [2]

(b) Calculate the extra amount Yusuf would need to repay in interest in the first year on a $4000 loan, both at the original 3% rate and at the new 6% rate. [2]

(c) Using your answers to (a) and (b), explain why a rise in the rate of interest from 3% to 6% is likely to make Yusuf more inclined to save and less inclined to borrow. [3]

Chidi and his partner have been planning to buy their first home. For the past year, banks in their country have been charging a high rate of interest on mortgage loans, so the couple have kept renting and continued to save toward a larger deposit instead. This month, the central bank sharply cuts the official rate of interest, and mortgage rates fall along with it. Household income, house prices and consumer confidence have not changed.

Based only on this fall in the rate of interest, what is Chidi and his partner most likely to do?