KSLU Solved Question Papers
Money, Banking and International Trade
Previous Year Question Paper with Solution
B.A. LL.B. (Five Years) · Sem 2
2019 Jun Examination
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Mumbai
B.A. LL.B. (Five Years) Sem 2 Money, Banking and International Trade 2019 Jun Question Paper with Solutions
First published on munotes.in on 21 October 2026.
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Contents
The questions below are the paper as Karnataka State Law University set it at the 2019 Jun examination, in the order it was set.
MarksPage
The Paper as Set
The questions in this volume are the questions asked at the 2019 Jun examination, reproduced as Karnataka State Law University set them, in the order it set them. Long reading passages are shortened to their first and last lines and our summary; the original paper prints them in full. Only the answers are ours. See the original question paper.
Duration 3 hours · Total marks 100 · 13 questions answered
How to use this volume
Solve the paper first, under exam conditions and against the clock. Then read the answers here and mark your own. Reading a solution before attempting the question feels productive and teaches very little, because recognising an answer is not the same as being able to write one.
Q1Critically examine the cash transaction approach to the quantity theory of money.[16]
Answer
For full marks, cover: what the quantity theory of money sets out to explain; Irving Fisher's cash transaction approach (1911), with the equation, the price level derived from it and Fisher's own statement; a critical examination of each of Fisher's three premises in turn, with evidence; four worked scenarios showing when the theory holds and when it fails; Fisher's own qualification about transition periods; a comparison with the Cambridge cash balance approach; what survives of the theory today, including India's experience with monetary targeting; a conclusion.
What the theory sets out to explain
The quantity theory of money explains the value of money, which is the inverse of the general price level. Its claim is simple: the more money there is, the higher prices will be, other things being equal. Irving Fisher gave it its best-known form in The Purchasing Power of Money (1911). His version is called the cash transaction approach, because it looks at money as it is spent in transactions.
Fisher's cash transaction approach
The equation of exchange. Fisher wrote MV + M'V' = PT.
- M, money in circulation (notes and coins), and V, its velocity, the number of times it is spent in a year.
- M', bank deposits that can be drawn by cheque, and V', their velocity.
- P, the general price level, and T, the total volume of transactions.
The left side is the money spent in a year. The right side is the value of what is bought. The two must be equal.
The price level. Rearranged, the equation gives P = (MV + M'V') / T as the formula for the price level. If velocity and trade stay the same and deposits move with cash, prices move in proportion to the quantity of money.
Fisher's statement. In his words, "the level of prices varies directly with the quantity of money in circulation, provided the velocity of circulation of that money and the volume of trade which it is obliged to perform are not changed". He added that "The price level is normally the one absolutely passive element in the equation of exchange".
Examining the three premises
Fisher rested the theory on three premises. Each must be examined in turn.
Premise 1: the equation of exchange. What Fisher said. Money spent equals the value of goods bought. Examination. This is true, but it is true by definition. It is an identity, like saying that what a buyer pays equals what a seller receives. An identity cannot show which way causation runs. Does more money raise prices, or do rising prices draw in more money? The equation alone cannot say.
Premise 2: deposits move in proportion to cash. What Fisher said. An increase in M normally causes a proportional increase in M', because banks keep a steady ratio of reserves to deposits. Examination. The ratio is not steady. India's money multiplier, broad money divided by reserve money, rose from 5.70 to 6.21 in the year to 31 December 2025. The Bank of England also explained in 2014 that "the majority of money in the modern economy is created by commercial banks making loans". Deposits therefore depend on banks' willingness to lend and borrowers' wish to borrow, not on cash alone.
Premise 3: more money does not change V, V' or T. What Fisher said. An increase in money does not normally affect velocity or the volume of trade, so it falls wholly on prices. Examination. This is the weakest premise.
- Velocity changes. In a slump, people and firms hold on to money, so V falls. In a boom, they spend faster, so V rises.
- Output changes. J. M. Keynes showed in The General Theory (1936) that when there is unemployment, more money can raise output. Only beyond full employment does it set up "a state of true inflation".
- Prices are not passive. A rise in oil prices or wages can push prices up first. Money may then expand to finance the higher prices, which reverses Fisher's causation.
Four worked scenarios
Start with M = 2,000, V = 4, M' = 4,000, V' = 2 and T = 1,600. Then MV + M'V' = 8,000 + 8,000 = 16,000, and P = 16,000 / 1,600 = 10.
| Scenario | Change | New P | Does Fisher's theory hold? |
|---|---|---|---|
| A. Money doubles, nothing else changes | M = 4,000, M' = 8,000 | 32,000 / 1,600 = 20 | Yes: prices double |
| B. A slump: velocities fall, money unchanged | V = 3, V' = 1.5 | 12,000 / 1,600 = 7.5 | No: prices fall with no change in money |
| C. Money and output both grow 10 per cent | M = 2,200, M' = 4,400, T = 1,760 | 17,600 / 1,760 = 10 | Yes: prices stay stable |
| D. Unemployment: money doubles and output rises half | M = 4,000, M' = 8,000, T = 2,400 | 32,000 / 2,400 = about 13.3 | Only in part: prices rise a third, not double |
Scenario A is the theory's own case. Scenario C shows the rule that money should grow with output. Scenarios B and D show the two failures: velocity and output do not stay fixed.
Fisher's own qualification
Fisher was aware of the limits. He wrote that the quantity theory is "not strictly true during transition periods", while the economy adjusts to a change in money. Keynes replied that people actually live in the transition. In his words, "In the long run we are all dead." A theory that holds only after all adjustment is complete is of limited use to a policy-maker.
The cash transaction and cash balance approaches compared
Cambridge economists looked at money differently. Alfred Marshall asked how much money people wish to hold, noting that "currency held in the hand yields no income". In A Tract on Monetary Reform (1923), Keynes wrote it as n = pk. Here k is the purchasing power people choose to keep in cash. He called this "the famous Quantity Theory of Money".
| Point | Cash transaction (Fisher) | Cash balance (Cambridge) |
|---|---|---|
| Looks at | Money spent: a flow | Money held: a stock |
| Key variable | Velocity, V | The share of income held as money, k |
| Why people use money | Medium of exchange | Medium of exchange and store of value |
| Point | Cash transaction (Fisher) | Cash balance (Cambridge) |
|---|---|---|
| Role of choice | Little: V set by habits | Central: people decide how much to hold |
| Covers | All transactions, T | Income or output |
The cash balance approach is the better foundation for later theory, because it brings in the demand for money. When people decide to hold more money, k rises, and prices can fall without any change in the money supply. That is scenario B seen from the other side.
What survives
- The long run. Over long periods, money that grows much faster than output does end in inflation. Milton Friedman restated this in 1970: "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output."
- Hyperinflation. Where governments print money without limit, prices rise with it, as the theory predicts.
- Policy rules. India's FRBM Act, 2003, by section 5, bars the Centre from borrowing from the RBI except through temporary ways and means advances. That closes the route by which deficits would become new money.
- India's experience. On the Chakravarty Committee's advice of 1985, the RBI targeted money growth, an approach that rested on a stable demand for money. It later moved to a multiple indicator approach. Since the 2016 amendment of the RBI Act, it targets inflation itself, at 4 per cent within a band of 2 to 6. The money supply is now watched, but not targeted.
Conclusion. Fisher's cash transaction approach states the quantity theory through MV + M'V' = PT. If velocity and trade are fixed and deposits follow cash, prices move in proportion to money. Examined premise by premise, the theory is weakest where it matters. The equation is an identity, deposits do not follow cash mechanically, and velocity and output change, especially below full employment. Scenarios A and C show where it holds and B and D where it fails, and Fisher himself excluded transition periods. The Cambridge cash balance approach improved on it by bringing in the demand for money. What survives is a long-run truth, restated by Friedman. India now acts on it by targeting inflation directly and by forbidding the monetisation of deficits.
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