Explain money's functions and banks' roles
Describe useful characteristics of money and distinguish central banks from commercial banks.
Cambridge IGCSE Economics 0455 / IGCSE (9–1) Economics 0987, 2027–2029 Version 1. Apply each model to the stated evidence and qualify conclusions where effects depend on context. Practice is original and self-checked; it is not a Cambridge paper, mark scheme or official grade.
Before you begin
- No prior economics study is assumed. Read the scenario for the decision-maker, the market or economy involved, the time period and the evidence supplied.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which institution typically accepts deposits and offers loans to households?
What you will learn
- Explain forms and functions of money
- Identify characteristics of money
- Compare central and commercial banks
Money makes exchange easier
Money is commonly used as a medium of exchange, a measure of value, a store of value and a standard for deferred payment. Cash and bank deposits are forms of money used in different settings.
Useful characteristics include portability, durability, divisibility, acceptability and relative scarcity. If trust or purchasing power changes sharply, money may perform these functions less effectively.
Central and commercial banks differ
A central bank manages a country's monetary system, may issue currency, acts as banker to government and commercial banks, and can implement monetary policy. Exact responsibilities vary by country.
Commercial banks accept deposits, make payments, lend and provide financial services to households and firms. Lending creates risks, so banks operate within regulation and may hold reserves; they do not simply lend every deposit unchanged.
Pause and explain
What is one role of a central bank?
Worked example
A buyer exchanges a bank deposit for a bicycle and agrees a loan repayment schedule. Name two functions of money involved.
Show the worked solution
- The deposit is used to pay for the bicycle.
- The agreed price lets buyers compare values.
- Repayment over time uses money as a standard for deferred payment.
Answer Money acts as a medium of exchange and measure of value; the loan schedule also uses it as a standard for deferred payment.
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Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Explain why a divisible and accepted form of money is more useful than a single indivisible good in exchange.
Give me a hint
Connect divisibility and acceptability to transaction size and trust.
Compare my reasoning
- Buyers need to pay different amounts.
- Divisibility supports small and large transactions.
- Acceptance lets sellers rely on receiving payment.
Divisibility allows money to match different transaction values, while acceptability means sellers are willing to receive it. Together they make exchange more practical than barter with one indivisible item.
Look for these in your work
- Transaction size addressed
- Divisibility explained
- Acceptance explained
A commercial bank raises its lending rate after the central bank changes its policy rate. Explain the relationship without treating the two banks as identical.
Give me a hint
Distinguish the policy-setting institution from a bank that responds to it.
Compare my reasoning
- The central bank sets or influences a policy rate.
- Commercial banks may adjust lending and deposit rates.
- The size and timing depend on competition, funding and contracts.
The central bank's policy can influence commercial banks' costs and market rates. A commercial bank may pass on some change, but the timing and amount depend on its funding and market conditions.
Look for these in your work
- Roles distinguished
- Transmission explained
- Pass-through qualified
If confidence in a currency falls, explain how this may weaken money's role as a store of value.
Give me a hint
Consider what one unit of money can buy over time.
Compare my reasoning
- A store of value preserves purchasing power for later use.
- Falling confidence may increase expectations of depreciation or inflation.
- Users may seek alternatives, though the outcome depends on policy and conditions.
If people expect the currency's purchasing power to fall, they may be less willing to hold it for later. Confidence and actual stability depend on economic conditions and credible institutions.
Look for these in your work
- Function identified
- Mechanism explained
- Outcome qualified
Common mistakes
- Treating credit itself as a physical form of money
- Confusing central-bank policy with a commercial bank loan
- Assuming every bank has identical duties in every country
What can you explain now?
Which characteristic helps money pay for both small and large purchases?
Compare with the explanation
Divisibility
Units can be divided to match transaction values.
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Make it stick
Which characteristic helps money pay for both small and large purchases?
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